The dark-cloud cover pattern consists of a long body white up candle, followed by a black down candle which opens above the first candle's high. This means there is a gap between the first candle's close and second candle's open.
The second candle then penetrates deep into the body of the first candle. The dark-cloud cover pattern occurs mostly in up-trends, but may also be seen in an up move within a consolidation. It is a reversal signal that predicts lower prices coming up. The reasoning behind it is similar to that of other reversal patterns. The bulls make a strong run with a long white candle, followed by an upward gap on the next candle's opening.
Normally these types of rallies are caused by investor exuberance. The gap is then quickly closed and price action never looks back, making a strong move downward. The further it penetrates, the more confident we can be of the pattern's success. So let's sum up the requirements:. In addition to these requirements, there are several factors which can improve the pattern's performance in real trading.
When traded on weekly charts, the dark-cloud cover pattern can be a fairly reliable reversal signal. It is similar to the engulfing pattern, with the added advantage that somewhat tighter stop losses can be placed due to the reduced average distance to the top of the formation. This can significantly improve the reward: Picture-perfect dark-cloud cover patterns are not very common in the forex, due to the requirement that there be a gap between the first candle's close and the second candle's open.
Gaps in the forex rarely occur except over the weekend when the market is inactive. This means that the probability of finding a gap during the week is quite low, so we can either ignore that requirement, or deal with a significantly reduced pool of signals.
This is not the case on weekly charts, however. As has already been noted, the dark-cloud cover is very similar to the bearish engulfing pattern, with a lesser degree of penetration of the bear candle into the bull candle. According to our rules, this makes the pattern inherently less reliable than the engulfing pattern.
How to Trade It: Without an inherent take profit target, we have to turn to other analyses to get that resolved. Besides that drawback however, the dark-cloud cover pattern is easy to trade and can even be discovered by automated pattern recognition software. Simply wait for the pattern to close, enter a short position according to your money management rules, set your stop loss above the dark-cloud cover's high in case the pattern fails, and enter your take profit target according to your other analysis.
Engulfing Pattern Piercing Pattern. Bearish Reversal Pattern Appearance: So let's sum up the requirements: Long body white candle in an up-trendnding or consolidating market. The following candle gaps up and opens above the first candle's high, meaning above it's shadow.
The further the second candle's close penetrates into the previous candle's white body, the more likely it is that the pattern is in fact forming a significant top in price, and the more likely therefore, that trades based on the dark-cloud cover will succeed. Please note that if it penetrates so far as to engulf the entire white candle, then we have a bearish engulfing pattern.
The shorter the shadows are on both candles, the better chance of success. It follows that the best performance comes with "shaved bottom" and "shaved head" candles, meaning no shadows at all, only bodies.
If the pattern occurs near a previous resistance level, we have further confirmation of a bounce, again increasing our probability of success.
A text-book pattern would have the first candle close near the resistance level, then gap up above it, only to be taken down by strong selling pressure. In markets where volume data is available, heavy volume on the second candle's open could indicate a last gasp by the bulls, very likely signalling an imminent strong "long squeeze" and sharp downward move.
Unfortunately, this information is not available to us in the retail forex market, at least not in any reliable form. See what other readers have to say, tell the world what you think.
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