The Dark Cloud Cover: A Warning Of Potential Price Reversal

The dark cloud cover is a bearish candlestick pattern that can signal a reversal at the top of an uptrend or a congestion band. It consists of two candlesticks: the first is a strong white candlestick, and the second is a black candlestick that opens above the high of the first day but closes near the low of the day, partially or fully within the body of the white candlestick.

The more the black candlestick penetrates the white candlestick, the more likely it is that a reversal is occurring. Some Japanese technical analysts consider a black candlestick that does not close below the midpoint of the white candlestick to be a less reliable signal of a reversal. It may be best to wait for further bearish confirmation before making a trade based on this pattern.

How the Dark-Cloud Cover Pattern Affects Market Trends

The market is currently in an uptrend and has been characterized by a series of strong white candlesticks. However, the trend was interrupted by a gap higher on the next session’s opening, which was followed by a lack of continuation in the rally. The market ultimately closed at or near the lows of the day, well within the prior day’s real body.

This bearish pattern may cause long-term investors to reconsider their positions and may provide an opportunity for short-sellers to place stop orders at the new high of the second day of the dark-cloud cover pattern.

Factors That Intensify the Importance of Dark-Cloud Covers

Dark-cloud covers, which are bearish reversal patterns characterized by a white real body followed by a black real body, can be more significant when certain conditions are present. These include:

• A greater degree of penetration by the black real body into the white real body that preceded it. A bearish engulfing pattern, in which the black real body covers the entire white body, is a more significant top reversal than a dark-cloud cover, which only partially covers the white body. If a long white real body closes above the highs of the dark-cloud cover or bearish engulfing pattern, it could indicate a potential rally.
• A strong white day with a shaven bottom (opening on the low) and a shaven head (closing on the high) followed by a long black real body day that opens on its high and closes on its low. This pattern, known as a shaven head and shaven bottom black day, can be especially significant during a prolonged uptrend.
• A failure by the black real body of the dark-cloud cover to break above a major resistance level. This could indicate that the bulls are unable to take control of the market.
• Heavy volume on the opening of the second day, which could indicate a buying blow off and a large number of new long positions. High opening interest in futures markets can also be a warning sign.

Significance

The appearance of the dark cloud cover pattern can be significant because it indicates that the bulls, who were in control during the uptrend, are losing strength and the bears are gaining strength. This can be an indication that the trend may be reversing and that it is a good time for traders to consider taking profits or even entering short positions.

Limitations

It is important to note, however, that the dark cloud cover pattern should be considered in the context of the overall trend and should not be relied upon as a standalone indicator. Other technical analysis tools and techniques, such as trend lines, moving averages, and volume analysis, can also be used to confirm the significance of the dark cloud cover pattern. Overall, the dark cloud cover pattern can be a useful tool for traders to identify potential trend reversals and make informed trading decisions.

The Bottom Line

In conclusion, the significance of dark-cloud covers can be intensified by the degree of penetration of the black real body, the presence of a shaven head and shaven bottom pattern during an uptrend, a failure to break above a resistance level, and heavy volume or high opening interest. These factors can provide insight into the potential for a bearish reversal in the market.