Dark Cloud Cover in Candlestick Trading


Candlestick charts allow the chartist to visualize an asset’s opening price, closing price, high, and low over each respective trading period. The candlesticks on the chart can be used alone to give a picture of a single period’s price action and market psychology, or in tandem as a pattern, which has been historically used to predict specific outcomes. Candlestick patterns can signal continuations of a trend, reversals of a trend, or an undecided market. One such pattern is the dark cloud cover candlestick pattern.

The dark cloud cover pattern is a two-candle bearish reversal pattern, meaning that it occurs in an uptrend and signals an imminent downtrend. This pattern can be found on a candlestick chart recording the price action of any asset and is used by traders alone as a signal or in conjunction with other indicators. 

In the remainder of the article, we will explain the composition, implications, and uses of the dark cloud cover candlestick pattern in more detail. 

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How to Identify the Dark Cloud Cover Pattern?

The dark cloud cover pattern occurs fairly often, but it is essential to differentiate between a true dark cloud cover pattern and a simple long white candlestick.

Construction and Key Characteristics of the Dark Cloud Cover Pattern

The pattern is made of two candlesticks and can only occur in a bull market. It is possible for two candles constructed like a dark cloud cover pattern to appear in a bear or an undecided market—but to be a true dark cloud cover, it must occur during an established upward trend. 

First Candle

The first candle continues with the trend and has a long white real body. It emphasizes the bullish market sentiment and shows that the bulls control the market. It can have shadows but does not need them. It is essential to note the high of the first candle, as the pattern is built from this. 

Note: It is typical to see a long white body in an uptrend; it is the second day that defines the dark cloud cover pattern.

Second Candle

This candle opens at or above the previous candle’s high (not just the close, but the high). This creates a gap between the two days. It then closes below the midpoint of the first period’s real body. Thus, it is a long or short black candle. The shadows are of less significance than the real body. 

Note: A bearish engulfing pattern is a two-candle pattern very similar to the dark cloud cover pattern. The second candle in this pattern, however, opens above and closes below the first candle, thereby “engulfing” the first candle in size. This is also a reversal pattern and stronger than the dark cloud cover. 

How to Interpret the Dark Cloud Cover Pattern?

This pattern is an excellent signal for a change in market sentiment. It can be understood as a change in control from the bulls to the bears; the length of the second candle demonstrates the bearish market sentiment and control because of the drop in price as the selloff occurs. 

Note: If one is in a long position, use this pattern to signal the end of the bullish trend and exit the trade by selling the assets held. 

How to Improve the Reliability of the Dark Cloud Cover Pattern? 

This pattern is reliable over fifty percent of the time, according to Tomas Bulkowski, but it is always prudent to confirm signals with other technical indicators or candlestick patterns. The following are useful in conjunction with the dark cloud cover pattern:

  • When followed by a Shooting Star Candle, this supports the bearish trend change.
  • When followed by a Gravestone Doji Candle, this supports the bearish trend change.
  • Oscillator indicators, such as a Stochastic Oscillator or Relative Strength Index, signal overbought levels and increasing selling pressure, and suggest a trend reversal. 

For the dark cloud cover pattern, in particular, there are a few characteristics to look for, which will improve the reliability of the reversal signal:

  • Closing further into the first day’s body betters the chances for a trend reversal as it signals more price changes caused by the bearish mentality and that the bears control the market. 
  • Longer candles show more strength in market sentiment changes and are more significant than candles with shorter real bodies. 
  • Long upper shadows improve the performance of this pattern. Especially on the second candle, it shows that even though the bulls increased the price, the bears won by the end of the period and removed all gains. 

How to Trade the Dark Cloud Cover Pattern in Candlestick Trading?

As a reversal pattern signaling the beginning of a bear market, it would be most prudent when spotted to short sell because the asset’s prices are expected to fall. Described below are a few things to consider when trading a dark cloud cover pattern –

Market Environment

As stated, a true dark cloud cover pattern can only occur in a bull market. Confirm the uptrend by drawing a trend line from the recent market lows. 

Identify and Confirm Trade Opportunity

This pattern is completed by a black candle closing below the midpoint of a previous white candle. When the second trading period closes, confirm the reversal with an oscillator indicator, which can confirm increased selling pressure, and inform if the asset is overbought. 

Determine Trade Entry, Stop Loss, and Take Profit Levels

Enter the market by placing an order for shares after the close of the second candlestick. You may also wait until the next trading period opens to confirm the new downtrend. Place a stop loss above the second candle’s open to prevent further loss if the price does not go down. Take profit when your risk appetite, other indicators, or convenience suggests it. Some suggest exiting the trade when the price drops to the level of the previous trough or when there are signs of another (bullish) reversal. Note: Short-selling can only be done with a margin account.

Execute and Manage Trade

Use a trailing stop, if the price continues to drop, placed above the highs of the proceeding candles as you hold the short position. 

Advantages and Limitations of Trading the Dark Cloud Cover Pattern

Now that we have covered the basics, let us discuss a few advantages and limitations of trading the dark cloud cover pattern.

Advantages of Trading the Dark Cloud Cover Pattern

Listed below are the major advantages of trading the dark cloud cover pattern – 

  1. It is relatively easy to spot and trade this pattern
  2. In comparison to other candlestick patterns, this pattern has a reasonable accuracy in trading

Limitations of Trading the Dark Cloud Cover Pattern

Listed below are the major limitations of trading the dark cloud cover pattern – 

  • It can be a signal for a short downturn, not a full trend reversal 
  • It is not as reliable as the full engulfing pattern

Candlestick Pattern Opposite to the Dark Cloud Cover

While a dark cloud cover pattern signals a bearish reversal, a piercing line pattern signals a bullish reversal in a downward trending market. As with the dark cloud cover pattern, this is a two candlestick pattern; the first is black and follows the trend, while the second is a long white candle, which signals the bulls have taken control.

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Conclusion

Candlestick patterns are an excellent tool for assessing market psychology and price action. The dark cloud cover pattern is a good pattern to learn when starting to trade because it can be used to signal an exit from a long position or an entry in a short position. 

Additionally, it works well in conjunction with other trend indicators and helps confirm the signals of other reversal indicators. Furthermore, they offer traders specific points to enter and place stop losses, which can otherwise be a daunting decision.

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    Navdeep Singh

    Navdeep has been an avid trader/investor for the last 10 years and loves to share what he has learned about trading and investments here on TradeVeda. When not managing his personal portfolio or writing for TradeVeda, Navdeep loves to go outdoors on long hikes.

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