Dark Cloud Cover: A Trader’s Insight
Dark Cloud Cover is a bearish reversal candlestick pattern where a downward candle (usually black or red) opens above the close of the prior upward candle (typically white or green), and closes below the midpoint of the up candle. This pattern signifies a momentum shift from bullish to bearish. Traders watch for a continued price decrease on the next candle, known as confirmation.
Key Takeaways
- Shift in Momentum: Dark Cloud Cover indicates a downside shift in momentum after a price rise.
- Pattern Description: It consists of a bearish candle opening above but then closing below the midpoint of the preceding bullish candle.
- Trader Participation: The candles should be relatively large, showing strong market activity. Smaller candles make the pattern less significant.
- Confirmation: Traders typically wait for a further price decline on the next candle to confirm the pattern.
Why Dark Cloud Cover Matters
The Dark Cloud Cover pattern forms a bearish indicator as it places a “dark cloud” over a previous bullish candle. Similar to a bearish engulfing pattern, buyers initially push prices higher at the open, but sellers subsequently gain control, pushing prices sharply lower – indicating an impending price reversal.
This pattern is most noteworthy after an existing uptrend or a sustained rise in price. Its significance diminishes in choppy market conditions where prices are likely to continue with erratic movements after the pattern forms.
Criteria for Dark Cloud Cover Pattern:
- Existing Uptrend: There should be an ongoing bullish trend.
- Bullish Candle: Present within the uptrend.
- Upward Gap: Occurs on the day following the bullish candle.
- Bearish Turnaround: The gap transforms into a bearish candle.
- Midpoint Violation: The bearish candle closes below the midpoint of the previous bullish candle.
Trading Strategies Using Dark Cloud Cover
The Dark Cloud Cover is characterized by white and black candlesticks with long real bodies and small or no shadows – indicating a decisive bearish movement. Following the pattern, traders often seek confirmation via a bearish candle to affirm the anticipated decline.
Traders might close long positions at the bearish candle’s close or after confirmation the next day when prices continue to drop. Conversely, traders might initiate short positions at these points, placing a stop loss above the peak of the bearish candle.
Although there isn’t a set profit target for the Dark Cloud Cover, traders often use other technical analysis tools to determine exit points for their short trades.
Successful traders also combine the Dark Cloud Cover with other technical indicators, such as a Relative Strength Index (RSI) above 70 to confirm an overbought status. A breakdown from a key support level post-pattern further signals a potential downtrend.
Real World Example of Dark Cloud Cover
Let’s consider an example in the Daily 2X VIX Short Term ETN (TVIX):
In this case, a Dark Cloud Cover pattern emerges when a third bullish candle is succeeded by a bearish candle that opens higher but closes below the midpoint of the last bullish candle. This predicts a subsequent downturn, validated when prices dropped nearly seven percent in the following session.
Traders eyeing the pattern could exit long positions near the close of the bearish candle or on the ensuing day when prices fell further. Conversely, short positions could be entered with initial stop losses above the bearish candle’s peak. After the confirmation day, the stop loss could be adjusted based on the price movements.
Through such insights, aspiring traders can become adept at identifying, interpreting, and acting upon the Dark Cloud Cover patterns to optimize their trading strategies.
Related Terms: Candlestick Patterns, Bearish Reversal, Confirmed Downtrend, Technical Analysis, Stock Trading.
