What is the Dark Cloud Cover candlestick pattern?

Technical analysis is a weapon of the stock market that makes trading more efficient for investors. Candlestick chart pattern is one of the tools of Technical analysis.It aids the traders in assuming probable future price movements based on past price behaviour. Dark cloud cover is one such candlestick chart pattern that aids traders in taking positions in the stock.

What is a Dark Cloud Cover?

Dark cloud cover is one of the candlestick patterns, which signals a potential downtrend from an ongoing uptrend. This pattern involves two candlesticks. First is a bullish candlestick and another is a bearish one.

The bearish candlestick notifies the traders about the end of the existing bullish trend. The name ‘dark cloud cover’ is given as a large black candle looks similar to a ‘dark cloud’ over the previous day’s sunny candle. Identifying this pattern is comparatively easy. Therefore, novice traders can identify and analyze this pattern, too.

The dark cloud cover pattern is formed when there is a high demand for the stock in the opening phase. It gives the buyers control over the price. Once the price goes higher, sellers take control later and push the price lower significantly. This shift to selling from buying signifies a more reliable potential reversal. If the same pattern is observed from the choppy trend instead of an uptrend, it tends to be less reliable.

The dark cloud cover pattern can be identified when a ‘bearish candle’ opens above the close of the previous ‘bullish candle’ but close below the midpoint of ‘bullish candle’. Traders can use this pattern to decide on the exit from a long position or entering a short position, as it spots an upcoming reversal.

The chances of reversal depend on the volume of stock traded when the candlestick is formed. If the volume traded is higher, there are huge chances of reversal and vice versa. Traders can better study the dark cloud cover pattern on higher time frames such as daily charts. Lower time frames are less significant.

Example of Dark Cloud Cover

The bearish candlestick of the stock of ABC Limited opens at 91.85, above the close of the previous bullish candlestick i.e. above 83.50. The bearish candlestick closed at 85.05, below the midpoint of bullish candlestick i.e. below 86.50. Though, the trader shall not assume that the dark cloud cover pattern is formed before looking at the third day’s candlestick. The next day, the stock opens at 93.20 and closes at 90.04. The candlestick formed will be a bullish one. This signifies the failure of the pattern.

The bearish candlestick of the stock of XYZ Limited opens at 114.90, above the close of the previous bullish candlestick i.e. above 107.50. The bearish candlestick closed at 108.55, below the midpoint of bullish candlestick i.e. below 118.45. The next day, the stock opens at 111.20 and closes at 113.50. The candlestick formed will be a bearish one. Here, the dark cloud cover pattern is confirmed. This suggests that the trader can exit his long position of XYZ stock or enter a short position.

Formation of Dark Cloud Cover

The dark cloud cover pattern forms when a bullish candle is followed by a bearish candle the next day with a ‘gap up’. This means a discontinuity in the stock price chart, from the previous close, without any trading occurrence between.

To decide on the formation of dark cloud cover, traders look for the following criteria:

1. An existing uptrend at first
2. Bullish candle with high length. The length shows the force of potential reversal
3. A gap up in the bearish candle on the next day
4. Bearish candle formation
5. Bearish candle closes below the midpoint of bullish candle

Moreover, both the candlesticks have large bodies and short or no shadow. Large candles indicate higher participation from traders. Small candles formation reduces the significance of this pattern. The pattern is confirmed when a bearish candle is followed by another bearish candle on the third day. This means if the price does not further decline on the third day, the pattern may fail.

Conclusion

To sum up, the dark cloud cover pattern is easy to identify candlestick patterns, which helps the traders by spotting potential reversal. Though the pattern is efficient, relying on it in isolation can be riskier for the traders. The reversal can be confirmed using a dark cloud cover pattern with other technical indicators. Traders shall note that no indicator can exactly predict the future stock performance, they only help in predicting potential behaviour.