Technical Analysis

Dark Cloud Cover Candle Stick Pattern

‘Dark Cloud Cover’ candle stick pattern is exactly the opposite of ‘Piercing Line’ Pattern.

It’s called a ‘Dark Cloud Cover’ when the pattern appears during an uptrend.

The ‘Dark Cloud Cover’ is a two-candle pattern that forms after the price has risen.

If it forms during an uptrend, it signals a possible turn towards a downtrend.

For the pattern to be called ‘Dark Cloud Cover’, the following has to happen:

  1. The stock has to be in a uptrend.
  2. The first candle has to be green (bullish).
  3. The second candle has to be red (bearish).
  4. The second red candle has to open higher than the first green candle.
  5. The second candle has to fall and close above the bottom of the first green candle.
Dark Cloud Cover Pattern

Psychology of Dark Cloud Cover Pattern

As you read the next few paragraphs, try to visualize the formation of ‘Dark Cloud Cover’ Candlestick pattern on the chart.

A stock has been on an uptrend for the last few days. One day, a big green candle gets formed on the chart – the price could’ve gone up by 3-5% or more. The buyers are totally in control, taking the price of the stock up.

On the second day, the stock opens gap up – i.e above the previous day’s closing price.

Then, suddenly the sellers recognize that the price has gone up too high in the last few days – they begin to see that the stock could be over-valued and may not be able to sustain the high valuations. They start selling, the price of the stock starts going down.

Before the end of the day, the stock falls to close slightly above the previous day’s opening (i.e above the bottom of previous day’s green candle).

This kind of sharp downward movement after a steady rise in the price over the last few days or weeks – suggests that the stock could reverse and begin moving downwards.

Dark Cloud Cover Trading Strategy

Let’s start with an example:

Dark Cloud Cover Candle Stick Pattern Example
  • The above image is a real chart of the Pharma company Abbott India.
  • Notice how the ‘Dark Cloud Cover’ candlestick pattern gets formed at the very top of the uptrend.
  • The stock was on an uptrend until then for the last few days.
  • Suddenly a big green candle appears.
  • On the next day, the stock opens higher (gap up) and then falls to close just a little above the bottom of the green candle.
  • This formation is called ‘Dark Cloud Cover’.

How to execute the trade:

  • The stock has to be in an uptrend or short term up-move. This is important.
  • After that, if the ‘Dark Cloud Cover’ pattern gets formed, traders can wait for the confirmation. Risk takers can take the trade with a strict stop loss.
  • The confirmation comes when the day after the red candle, the stock once again turns bearish and begins falling.
  • A trader – depending on his risk appetite – can short sell immediately after the confirmation or once the price falls below the low of the first green candle.
  • When the confirmation comes, traders can short sell the stock.
  • The stop loss can be the top of the green candle. If the price goes above that, the ‘Dark Cloud Cover’ Pattern has failed. The trade is over, the position should be closed and the loss should be booked immediately.

Why Booking Loss is Important:

  • Booking loss is a very important part of becoming a successful trader. If your setup has failed, the loss should be booked immediately. After that further analysis can be done on why the trade failed.
  • Not taking loss and waiting for the stock to turnaround – is a mistake which many new traders do. If you bought because of the ‘Dark Cloud Cover’ candlestick pattern, then if that pattern fails, you need to close the trade and get out of your position as soon as the stop loss hits.
  • It’s better to enter the ‘Stop Loss’ in the system itself, so that the computer can automatically close the trade and book the loss.
  • Maintaining discipline and being unemotional about your trades is also very important.

Importance of Volume in Dark Cloud Cover Pattern:

Another important thing to notice is the volume. When the volume on the red candle is higher than the volume of the green candle, it’s considered to be a strong sign that the trade is likely to succeed.

In other words, it means, the number of shares traded (volume) was lower on the day of the green candle. But on the next day, a lot of shares were sold – which is why the stock has fallen.

If the volume on the red candle day is way higher than the average volume of the last few days, then it could mean a more well-informed big investor has exited the stock.

These are some of the many indications of what could follow in the next few days.

Dark Cloud Cover Pattern for Long Term Investors

This candlestick pattern is not meant for long term investors. It’s a short term trend indicator.

However, in some circumstances the ‘Dark Cloud Cover’ pattern can be used effectively even by medium or long term investors.

Let’s say, you have 100 shares of Reliance Industries. The price has gone up a lot in the last few days. You are wondering if you should partially book some profit.

Here, if the ‘Dark Cloud Cover’ pattern gets formed and the red candle comes with high volume. You could look at look at selling around 25% of your holding and keep some profit.

You can buy back the shares later when the price corrects.

These strategies vary from person to person. Some long term investors believe in buying and holding their shares forever. While others are keen on regularly booking some profit.

Learning Technical Analysis can help you sell shares closer to their highs and buy back those shares later at a lower price.

If you have any questions related to ‘Dark Cloud Cover’ Candle Stick Pattern, post them in the comments section below.

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