Dark Cloud Cover Candlestick Pattern
The Dark Cloud Cover candlestick pattern is a bearish reversal candlestick pattern that develops at the top of uptrends. A Dark Cloud Cover candlestick pattern indicates that dark times are most likely ahead for the stock’s share price, hence the name of the candlestick.
When a Dark Cloud Cover candlestick pattern develops, it starts with its share price gapping higher when the market opens. This is due to unusual buying in the pre-market hours. Once the market opens though, the buying rally seems to be short-lived as profit-takers and short-sellers both step in and immediately start selling shares.
By the end of the trading session, the stock’s share price has reversed course from its bullish opening and has closed 50% or more into the real body of the preceding candlestick. This is a powerful bearish reversal indicator that signals a trend reversal either just started or is almost ready to begin.
I have a theory that short-sellers help to create the early buying frenzy in the pre-market by buying shares before the regular trading session begins. This creates the continued bullish atmosphere and implies that the good times are still going. This pre-market buying usually involves a gap-up for the share price when the market opens.
However, once the market does officially open, the short-sellers stop bidding up the market and immediately start selling all their purchased shares. Once they run out of purchased shares, which happens pretty quick, they start shorting the market. The short-sellers created a “Bull Trap” in the early trading hours. As the trading session progresses, the continued selling creates downwards pressure on the stock’s share price, sending its share price lower.
A Dark Cloud Cover candlestick pattern indicates that the uptrend probably just ended. The buyers (bulls) thought they were in control of the market, enjoying an early morning gap-up that immediately which pushes slightly higher as the morning progresses. However, a wave of sellers then step in right when the bulls think they are in control and a massive wave of selling tends to take place.
Requirements
Listed below are the requirements and characteristics for Dark Cloud Cover candlestick patterns.[s2If !current_user_can(access_s2member_level1)]…..
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- Its real body is always colored red
- Its share price must gap-up and open above the preceding candlestick pattern’s real body
- The share price for the Dark Cloud Cover candlestick pattern must close at least 50% or more into the real body of the previous candlestick pattern
- The share price for the Dark Cloud Cover candlestick pattern should close at or near its low for the trading session
Characteristics & Observations
Listed below are some of the other characteristics for Dark Cloud Cover candlestick patterns as well as some of my observations.
- In order for a trend reversal to take place, the share price must have been in a clearly defined uptrend before forming a Dark Cloud Cover candlestick
- It is a very powerful, bearish reversal candlestick pattern
- When it develops on volume that is heavier than the preceding candlestick’s volume, the chances for a trend reversal are significantly increased
- It is not necessary to gap-up above the top of the preceding candlestick’s upper shadow, however doing so would constitute a stronger bullish move than just gapping above the preceding candlestick’s real body
- The lower the Dark Cloud Cover candlestick closes into the previous candlestick’s real body, the greater the chance for a trend reversal
- Some of the more significant Dark Could Cover candlesticks I have seen involve Bearish Belt Hold candlestick patterns as well, meaning that the two candlestick patterns are combined and create a powerful bearish reversal candlestick pattern. When this happens, the chances for a trend reversal are increased significantly.
Bullish Counter-Part
The bullish counterpart to the Dark Cloud Cover candlestick pattern is the Piercing candlestick pattern. Both of these candlestick patterns must close at least 50% or more into the previous candlestick’s real body as one of their requirements.
I consider Dark Cloud candlestick patterns and Piercing candlestick patterns to offer higher probability trading opportunities when they are identified on a stock chart.
When either of these patterns are accompanied by heavier than normal trading volume, the probabilities increase.
When either a Dark Cloud Cover candlestick or a Piercing candlestick is also a Belt Hold Candlestick Pattern, the probabilities for a reversal increase again.
Resistance Area
The resistance area for a Dark Cloud Cover candlestick is the very top of its upper shadow. If the candlestick does not have an upper shadow because it is a Bearish Belt Hold candlestick pattern also, then the top of the real body is considered the resistance area.
Once a candlestick can close above the resistance area from the Dark Cloud Cover candlestick, then the resistance are will be considered broken. Share prices tend to increase faster upon the initial break of the resistance area.
But when aDark Cloud Cover candlestick pattern develops on heavier than normal selling volume, do not anticipate a break above the resistance area on the 1st attempt. Or the 2nd attempt. As they say though, the 3rd time is usually the charm.
Trading Strategies
I will review 2 different trading strategies for this bearish reversal candlestick pattern. The first strategy will review scaling-out of a position that you hold when the candlestick pattern develops. The second and more aggressive strategy will involve entering into a short sale position based on further anticipated declines in the share price.
Always be sure to step back and analyze the “trend of one larger degree“. This can help you determine if the pullback is going to be shorter-term in nature or if it is the start of something extremely more bearish in nature.
If You Are Currently Long the Stock
You may have noticed other sell signals flashing before the development of the Dark Cloud Cover candlestick pattern. If you did and already scaled out of a few shares, congratulations. If that is not the case and you are still holding all your shares, you will want to begin a scale-out process. Use the very first re-test of the resistance area as an opportunity to make the first scale-out sale, regardless of the outcome. Make the sale as soon as the share price gets to the resistance area.
If the re-test of the resistance area fails, as it usually does on the first re-test, another scale-out sale could be made. That would leave you with about 1/3 of your holdings left. I prefer to use a 3 step scale-out process. If you want to be sure to lock in gains at higher prices, you can be more aggressive and use a 2 step scale-out process. You can determine what you want to do with the last 1/3. If share prices do decide to push higher, you still have a handful of shares left to enjoy a little of the upside that is left before the bigger downtrend.
One thing to keep in mind is the scale of the chart where you see the Dark Cloud Cover candlestick develop. Is it a daily chart? Is it a monthly chart? The scale of the chart will help to determine the speed in which your selling actions need to take place.
For example, if you notice a Dark Cloud Cover candlestick pattern develop on a monthly candlestick chart, you may have 1-3 weeks to execute the scale-out process and try to maximize profits. But be quick because a larger drop is coming. When a Dark Cloud Cover candlestick pattern develops on a daily candlestick chart, you may between 1-3 days to execute the scale-out process.
It is very important to keep everything in perspective based the scale of the chart you are analyzing. Also use other technical analysis methods for confirmation rather than relying on the candlestick pattern by itself. These other method can help to provide additional areas that can be used as scale-out areas once the downtrend is confirmed.
If You Are Looking to Short the Stock
Since this candlestick pattern is a major top indicator, the trading strategy would be to sell the stock short as soon as the price breaks re-tests the resistance area from the candlestick. Like entering into a long position, use a scale-in strategy when entering into your short position. Use the re-test of the resistance area to make a short sale equivalent to 1/3 of your total sale. Before making the next 1/3 sale, ensure that selling momentum and selling volume are both increasing. Selling volume should be well above normal trading volume.
A MACD Histogram is a great tool to use when monitoring buying and selling momentum. Make sure there is an increase in the selling momentum along with selling volume after the development of the Dark Cloud Cover candlestick pattern. Any slow down in selling momentum is an early indicator to start analyzing the charts and thinking about locking in short sale profits. This is simply done by purchasing shares to cover the shares sold short.
Since prices tend to move down quicker than they move up, short selling can be a very profitable trading strategy. However, it does carry the additional risk of “unlimited losses” when compared to going long on a stock. You need to know when to lock in losses in order to be a successful short seller. If you have a hard time selling anything for a loss, don’t use short-selling as a strategy. If you are not quick to pull the trigger on a loss, that loss can start leading to exponentially larger losses.
In order to minimize risk on a short position, only enter into a short sale trade after capitulating buying volume takes place. Look for a Climax Top volume spike. A capitulating volume spike helps to confirm the bearishness of a Dark Cloud Cover candlestick pattern.
Stop-Loss on Short Sale
To try and further minimize risk, a stop-loss order should be used on all short trading strategies. For a Dark Cloud Cover candlestick pattern, place the stop-loss order in 1 of 2 places:
- at the resistance area from the pattern as described above
- place a tighter stop-loss slightly above the 61.8% retracement point of the Dark Cloud Cover candlestick itself
- a tighter stop-loss order will try to limit losses on any attempted push above the resistance area from a Dark Cloud candlestick pattern
- a tighter stop-loss order will try to limit losses on any attempted push above the resistance area from a Dark Cloud candlestick pattern
After forming the 2nd candlestick in the Dark Cloud Cover candlestick pattern, any meaningful downtrend should probably start within the next candlestick or two. Look for the selling volume to start increasing along with an increase in selling momentum as indicated by the MACD Histogram chart tool.
Real Chart Examples
This 5 year monthly candlestick chart for Sirius XM Holdings illustrates a Dark Cloud Cover candlestick pattern that developed on its chart a couple months back. The Dark Cloud Cover candlestick pattern did develop on selling volume that was greater than the previous months volume.
Analyzing a Resistance Area Created by a Dark Cloud Cover Candlestick Pattern for Sirius XM Holdings (SIRI); the Dark Cloud Cover Candlestick Patter Developed on Heavier than Normal Selling Volume
Sirius XM Holdings (SIRI) has broken above the resistance area from the Dark Cloud Cover candlestick pattern. However I prefer 2 closes above a resistance area before I consider it negated. Otherwise, market makers could simply be setting a “Bull Trap”.
SIRI successfully closed out December 2016 above the resistance from the Dark Cloud Cover candlestick pattern in addition to November’s close above it. The close was not as high as illustrated above, but it did close above it none the less.
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