Monday, October 31, 2011

Dark Cloud Cover

A Dark Cloud pattern encountered after an up-trend is a reversal signal, warning of "rainy days" ahead.

Essentially, the large black candle is forming a "dark cloud" over the preceding bullish trend.

The dark cloud must have a closing price that is:
1) within the price range of the previous day, but
2) below the mid-point between open and closing prices of the previous day.
Dark Cloud Cover
Dark Cloud Cover is a bearish candlestick reversal pattern, similar to the Bearish Engulfing Pattern.
There are two components of a Dark Cloud Cover formation:
  • Bullish Candle (Day 1)
  • Bearish Candle (Day 2)
A Dark Cloud Cover Pattern occurs when a bearish candle on Day 2 closes below the middle of Day 1's candle.
In addition, price gaps up on Day 2 only to fill the gap (see: Gaps) and close significantly into the gains made by Day 1's bullish candlestick.
The rejection of the gap up is a bearish sign in and of itself, but the retracement into the gains of the previous day's gains adds even more bearish sentiment. Bulls are unable to hold prices higher, demand is unable to keep up with the building supply.
The chart below of Boeing (BA) stock illustrates an example of the Dark Cloud Cover Pattern:
Sell Signal
Traders usually suggest not selling exactly when one sees the Dark Cloud Cover Pattern (Day 1 & Day 2) until other confirming signals are given such as a break of an upward trend line or other technical indicators.
One reason for waiting for confirmation is that the Dark Cloud Cover Pattern is a bearish pattern, but not as bearish as it could be: part of the gains from Day 1 has still been preserved.
A more bearish reversal pattern is the Bearish Engulfing Pattern that completely rejects the gains of Day 1 and usually closes below the lows of Day 1.