Dark Cloud Cover
The Dark Cloud Cover is a bearish reversal pattern that occurs after an uptrend. It is significant over all time units. It is less powerful than the bearish engulfing.
Its bullish equivalent is the bullish piercing line.
Its main characteristics are:
- The Dark Cloud Cover must appear after an uptrend.
- The 1st candlestick must be green and preferably powerful.
The 2nd candlestick’s body must be red and open above the highest values of the day before.
The 2nd candlestick must close at least below the middle of the 1st candlestick.
Such a pattern is formed when, after an uptrend, the day after gains are made, prices open gap up and above the highest of the day before while bullish forces dry up and prices fall before finally closing below the middle of the Japanese candlestick of the day before. Thus, most of the gains of the day before are erased.
Given that volumes are often strong during a gap open, all buyers who entered at the open are now losing and most of them abandon their positions, what triggers the new downturn. The lower shadow of the 2nd candlestick should ideally be short since it shows that the bears are now in charge and that the bulls have not succeeded in making prices rise again. In this example, the next day will open with a slight gap down, what confirms the strength of the new downtrend.
The deeper the 2nd candlestick’s body enters in the 1st candlestick’s, the more significant the structure. When it covers it completely, we witness another bearish engulfing pattern. Strong volumes can also confirm the chart.
Regardless of the quality reached by the Dark Cloud Cover, it is better to wait for the confirmation of the pattern by the next Japanese candlestick that should open low if one wishes to sell uncovered at D+1 (D being the day of the 2nd candlestick of the engulfing pattern) or should be red if one prefers to wait for the next closing and sell uncovered at the opening of D+2.
The invalidation threshold can be placed either above the highest point of the pattern, or according to the Thirds Rule, depending on the stakeholder’s investment intentions.
Moreover, it is interesting to combine the observation of the reversal patterns and of the support and resistance lines. It may happen that a Dark Cloud Cover forms in a resistance zone, then goes through it and thus reinforces the chances of success of the reversal.
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