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Candlestick Patterns: Dark Cloud Cover

Dark Cloud Cover

The dark cloud cover pattern is a two-bar candlestick pattern found at the end of an uptrend.  This pattern is the bearish version of the Piercing Line pattern.

In this pattern, the first day is an up day and on the second day the price gaps up (opens higher) than the highest high that the stock price traded at on the previous day.  The price then falls throughout the second day and closes below the midpoint of the first day.  This suggests that after a long uptrend, sellers have decided to liquidate their positions in the stock.  This could be a sign that the stock is about to enter a new downtrend.

Generally speaking this is a bearish sign, and this pattern usually signifies a reversal to the downside.  For someone who purchased the stock at the beginning of the second day in this pattern, you would be questioning the timing of your purchase and could potentially be stopped out of your position depending on your trading or investing style.  If the second day is accompanied by a surge in volume, it is generally accepted that this signal is more reliable.  The further down the white candle the price closes at, the more convincing the trend reversal.

The significance of this pattern is confirmed if on the day following the dark cloud cover pattern the next candlestick gaps down or closes lower yet again, suggesting that the downwards momentum is building up.  It is key that this pattern occur at the end of an uptrend.  It can also occur in a consolidation area into resistance.  A dark cloud cover that meets these criteria is a potential short candidate and short sellers can profit from this pattern by initiating new short positions below the close of the second day in the pattern.

Different studies put the accuracy of this signal in the 60% range.  Here is an historic example of a dark cloud cover pattern and the implications that this chart pattern had in the future price movements of the stock:

 

Dark Cloud Cover Example: Altria Group (MO)

 

On July 31st 2012, a dark cloud cover pattern is shown in the following chart.  July 30th was an up day, and on July 31st the stock price opened higher than the stock traded at on the 30th and then started to drop in price.  The drop continued throughout the day and the stock closed below the midpoint of the first day in the pattern.  This suggests that buyers were coming into the stock on the morning of the 31st but then supply of the stock came in at that price level and the price was pushed down to support found in the previous trading range.

The next day, with a solid black candle, does not officially meet the ordinary confirmation criteria for this pattern but with a large upper shadow and relatively weak closing price, it certainly does not look bullish.  Let’s see what happens over the next few months.

 
 

As you can see the dark cloud cover pattern perfectly caught a new downtrend at the peak in price. The stock lost 20% of its value over the next 3 ½ months before finding some support and enjoying a relief rally. Notice how it sold off again at resistance in late November / early December of 2012.

 
 

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Colin Macleod

Colin Macleod is a Professional Equities, Options, Futures, Momentum Day Trader & Entrepreneur.

Colin Macleod – who has written posts on Stock Market Basics.