What is a Dark Cloud Cover?

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There are different kinds of candlestick patterns that traders use to analyse historical price movements and predict future trends. Some candlestick patterns confirm a bullish or bearish market, while others may indicate a reversal of prevailing trends. One common mistake traders make with trend reversal patterns is executing trades before confirming a reversal. And while both types of patterns are important for traders, trend reversal patterns can be particularly challenging to identify and confirm. In this article, we’ll take a closer look at one such trend reversal indicator, namely the dark cloud cover candlestick pattern. 

What is a Dark Cloud Cover Pattern?

The meaning of the dark cloud cover pattern is simple. It is a pattern that indicates a reversal from a bullish trend to a bearish trend. Typically occurring at the top of an uptrend, this is a two-candlestick pattern that consists of a green candle or an up candle followed by a red candle or a down candle. 

The occurrence of the dark cloud cover pattern alone does not guarantee a trend reversal. As with all reversal patterns, the dark cloud cover must also be confirmed or rejected based on the candlestick that occurs on the third trading day, i.e. the trading day following the two that pertain to the dark cloud cover. 

Also Read: What is the Inverted Hammer?

What Does the Dark Cloud Cover Look Like?

In terms of its appearance, the dark cloud cover pattern consists of two candlesticks. The first candlestick is a green or up candle. The size of its real body and shadows is not really pertinent to the pattern. The second candlestick is a red or down candle. 

To qualify as a dark cloud cover, the green and red candlesticks need to meet the following criteria regarding their appearance.  

  • The red candle should open above the green candle’s closing price
  • The red candle’s closing price should be around the midpoint of the green candle
  • The red candle engulfs the top half of the green candle

When represented in black and white, the black candle covers the top half of the white candle, making it appear like a dark cloud cover. 

Also Read: What is Pyramid Trading?

Important Criteria for a Dark Cloud Cover

To qualify as a dark cloud cover pattern, there are some criteria that need to be met by the two candlesticks in particular and the market in general. They include: 

  • A general bullish uptrend in the market 
  • A green or up candle during this bullish trend
  • A gap-up on day 2 when compared with day 1
  • The gap-up on day 2 results in a bearish or red candle
  • The red candle closes below the green candle’s midpoint 

What Does the Dark Cloud Cover Indicate?

Now that you know the meaning of the dark cloud cover pattern and how it looks, let us take a deep dive into the significance of the candlesticks and what they indicate. The first green candle that occurs at the top of a bullish trend is a signal that the trend is continuing, with the buyers being stronger in the market than the sellers. 

On the second trading day, the red candle opens at a price that is higher than the previous green candle’s closing price, thus continuing the uptrend. However, at some time during the second trading day, the bears or the sellers gain momentum and drive the price down — way below the opening price and almost below the midpoint of the previous day’s candle. The price closes well below its opening on day 2, resulting in a red or bearish candle. 

This indicates that the bears have gained momentum in the market. That said, there is no guarantee of the sellers’ strength continuing on the next trading day. This is why it is important to wait to confirm or reject the trend reversal on the third trading day. If the red candle in the dark cloud cover candlestick pattern is followed by another bearish or down candle, you can safely say that the trend has reversed from a bullish to a bearish price movement. 

Also Read: What is a Bear Market?

What To Do If You Notice the Dark Cloud Cover on a Chart?

If you notice that a dark cloud cover candlestick has appeared on a price chart, here is what you should typically do.

  • Ensure the pattern has formed after a clear uptrend because it’s a bearish reversal signal.
  • Check the trading volume on the day of the bearish candle, because an increase in the volume provides further confirmation of a potential reversal.
  • Identify nearby support levels because the pattern’s bearish implications might be negated if it forms near a strong support level.
  • Wait for subsequent candles to confirm a potential change in trend. 
  • If you are considering a short position, set a tight stop-loss above the dark cloud cover pattern’s high to keep potential losses to a minimum.
  • Check for external news or events that might influence the stock market because sometimes, they can overshadow technical patterns.

Conclusion

A dark cloud cover is the opposite of a piercing line pattern, where you have a red candle followed by a green candle. Unlike the dark cloud cover candlestick pattern, the piercing line is a bullish reversal trend. However, all candlestick patterns are merely indicators of potential market movements. 

Make sure that you always account for unpredictable market changes and the potential losses they may cause. This is particularly true in a volatile market, where significant price changes can occur over very short intervals. 

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