How to trade Dark Cloud Cover Candlesticks with Example: FKnol.com

The dark cloud cover is a form of bearish reversal candlestick pattern which forms on the bullish uptrend and results in the possibility of the price reversing to move downwards. It is the opposite of the Piercing Line Pattern.
The name follows the creation of couple of lengthy candles at the top - that is, at the top of the bullish move.
It is formed as a two-line pattern needing two adjacent candles. The first candle is a bullish green candle which is the part of an ongoing uptrend. The first candle needs to have an appropriate length and it cannot be a doji candle.
The second candle, which immediately follows the first green-colored one, is a red-colored bearish candle with certain specific characteristics. Its location is such that its body is placed slightly above the body of the first candle, and its close price is below the midpoint of the first candle's body but above the first candle's open price.
Most of the active traders usually wait for the next confirmation candle to form before getting into the trade on a dark-cloud-cover-based candlestick pattern. When formed on an uptrend, the confirmation candle should be red in color representing the price reversal to the downward direction. This article explains the details of how the dark cloud cover candlestick is formed, what market conditions are indicated by its formation, how to trade the dark cloud cover candlestick, and the article also covers the most recent examples of the same. To understand the working and trading of the dark cloud cover candlestick, let's start by checking the factors needed for its formation.

Construction of the Dark Cloud Cover Candlestick

The dark cloud cover candlestick pattern can lead to a strong signal for price reversal, if along with its formation a few more factors are kept in mind to get into a trade. Its first candle should be a bullish green-colored candle which should be a part of an uptrend. This candle should be a non-doji candle - that is, it should have a suitable length.
The next candle which forms should be red in color, which indicates the initial sign for a reversal to possible downward move. This second candle should also have a suitable length almost comparable or atleast 60% of the length of the first candle. Additionally, the closing price of the second candle should be slightly above the opening price of the first candle. Further, the close of the second candle should be below the midpoint of the first candle's body, and it should close above the first candle's open price. This means the body of the second candle should be placed in such a manner as if it is a little above the body of the first candle as if it is shifted a bit higher overall. This is how a typical dark cloud cover candlestick appears:

Formation of a dark cloud cover candle pattern indicates that the price reversal is possible, and the ongoing trend of the green-colored bullish candles is expected to end soon. Before entering a trade based on the emergence of the dark cloud cover pattern, many traders may like to wait for a confirmation candle to be formed immediately after the dark cloud cover candle. If a red-colored confirmation candle is formed at the third place, it further supports the probability about the price decline in near future and the end to the upward price move. Its time to go short on the stock (sell), or cut the losses if already holding a long position.

Trading the Dark Cloud Cover Candlestick

The dark cloud cover patterns can be spotted regularly on the price charts of various securities - like those of stocks, ETFs and market indexes. Since it appears commonly, one must remain cautious to only enter into a trade when all the necessary requirements are met. Failure to match all the specific conditions may lead to acting on a false signal and consequently leading to losses.

Here are the important pointers to consider before placing a trade on the dark cloud cover candle.
During the initial uptrend prior to the formation of the dark cloud cover patter, the bulls (buyers) were driving the market and had advantage over the bears (sellers). This results in formation of the uptrend comprising of several green-colored candles. It is after this a red-colored candle appears with suitable length and placement which completes the dark cloud cover. It is the primary signal that the price which started from a high value of open, and then went all the way down to a low value as was pulled down up by the sellers who are attempting to make a come back in the market. This situation now moves from buyer-dominant to that having a buyer-seller equilibrium.
Then comes the confirmation candle of red color indicating a confirmed reversal to the bearish trend. The longer this confirmation candle, the higher the chance of a continued up move. It will mean that sellers have now taken charge of the market prices with high supply and are dominating over the buyers.
If either of the dark cloud cover second candle and/or the confirmation candle is accompanied by a relatively higher trading volume, then it improves up the probability of price reversal. The sellers have returned to the market in full swing with high supply, and hence they are getting stronger and are able to pull down the prices. Therefore, its time to go short - that is, sell the security, or cut the losses if holding a long position.

The dark cloud cover candle pattern gains significance when formed during the uptrend. The formation establishes the backdrop for a potential reversal to downward move in the stock prices. Traders enter the trade when the dark cloud cover is formed at the breakout of the upper Bollinger band, or at the breakout of the trend-line (like 200-day moving average), or at the breakouts of any other suitable ranges they may track. The larger the breakout indicated by the length of the candlestick, the stronger the possibility of a reversal pattern. If the dark cloud cover is formed in the middle Bollinger band or far away from the trend-line (without breaching the trend-line), then the traders may not consider it as a strong reversal signal and they avoid the trade. When formed around the middle band or away from the breakout range, the dark cloud cover often leads to continuation of the existing trend instead of a reversal.

Trading Scenario for Dark Cloud Cover

The following are the general considerations and scenario for trading the dark cloud cover candlestick.

▶ Trade Entry: Formation of the dark cloud cover candlestick pattern during a uptrend is taken as a sign of reversal, that is - the market prices are expected to go down in the near term. So traders try to take a short sell trading position at or around the high price of the second dark cloud cover candle. Since many traders may like to wait for the confirmation candle to form, their selling price may be lower as the trend already pushed the prices lower. This will mean subsequently lower profits - and that's the tradeoff one needs to accept if waiting for a confirmation candle.

▶ Stop-loss Limit: The stop-loss varies from trader to trader based on their individual trade preferences, but usually while going long they set the stop-loss at 2-3 units below the low price of the dark cloud cover baby candle. Others who enter at a higher price should adjust the stop-loss proportionately.

▶ Profit-levels: While active trading at short intervals, traders must follow a risk-reward ratio to determine the possible profit level from their dark cloud cover pattern trading. For instance, if the stop-loss limit is set at $10 for the trade (the maximum loss one is willing to take on a trade) and the risk-reward ratio one follows is 1/2, then one must take profits when it hits $20. If the risk-reward ratio being followed is 1/3, then one must aim for profits when the price hits a level that generated $3 for every $1 stop-loss set.

▶ Market Conditions: Along with the above mentioned dark cloud cover formation requirement, traders should ensure that their selected price range, bands or trend-line limits are getting breached with large moves of the second bearish (and subsequent) candle. This ensures higher success rate of profitability. Although one must note that trading on technical analysis like candlestick patterns has limited success rate, so following strict stop-loss, disciplined trading and efficient capital management is advised.

Example of Dark Cloud Cover Candlestick

The following chart shows an instance of dark cloud cover candlesticks and the uptrend that followed shortly after:

As one can observe in the above chart, the dark cloud cover candle pattern which emerged and was followed by a confirmation candle that finally reversed the ongoing uptrend. It led to a downward move indicated by the long red arrow. Additionally, there was a range breakout, though with a nominal value, which added to the possibility of the price reversal.
Traders usually set their profit targets and stop-loss levels based on the risk-reward ratio of their choice as mentioned in the previous section.

Latest Dark Cloud Cover Formations

FKnol.com has a dedicated section on candlesticks where the list of stocks, ETFs and indexes forming dark cloud cover candles is updated on a daily basis. At present, the following are three examples - one each from stocks, ETFs and indexes - which have formed the dark-cloud-covers as of the mentioned date (in reverse chronological order):
1) On Tuesday, Jan 26, 2021, the stock price of Finance sector based Mastercard Inc. (MA) formed the following Dark Cloud Cover Candlestick pattern:

Day	Open	Close	Body Length
Today's	$330.00	$327.70	$2.30
Previous Day's	$327.51	$329.19	$1.68
Today to Previous Day's Body Length Factor:			1.37

		$330.00
$329.19
		$327.70
$327.51

See full details and past history of Dark Cloud Cover Candlesticks for Mastercard (MA)

▶ Full list of stocks which most recently formed the Dark Cloud Cover Pattern

2) On Tuesday, Jan 26, 2021, the price of Large-Cap based Vanguard S&P 500 ETF (VOO) ETF formed the following Dark Cloud Cover Candlestick pattern:

Day	Open	Close	Body Length
Today's	$354.23	$352.80	$1.43
Previous Day's	$352.71	$353.33	$0.62
Today to Previous Day's Body Length Factor:			2.31

		$354.23
$353.33
		$352.80
$352.71

See full details and past history of Dark Cloud Cover Candlesticks for Vanguard S&P 500 ETF (VOO)

▶ Full list of ETFs which most recently formed the Dark Cloud Cover Pattern

3) On Thursday, Jan 21, 2021, the value of popularly tracked leading stock market index S&P MidCap 400 (MID) formed the following Dark Cloud Cover Candlestick pattern:

Day	Open	Close	Body Length
Today's	$2,472.67	$2,453.24	$19.43
Previous Day's	$2,451.86	$2,469.01	$17.15
Today to Previous Day's Body Length Factor:			1.13

		$2,472.67
$2,469.01
		$2,453.24
$2,451.86

See full details and past history of Dark Cloud Cover Candlesticks for S&P MidCap 400 (MID)

▶ Full list of Market Indexes which most recently formed the Dark Cloud Cover Pattern

...and there's more. FKnol.com everyday checks the stock price and candlestick formation across hundreds of stocks, ETFs and indexes to look for dark cloud cover formations. Please see the full list of recent dark cloud cover formations for:
▶ Full list of recent Dark Cloud Cover Stocks
▶ Full list of recent Dark Cloud Cover ETFs
▶ Full list of recent Dark Cloud Cover Indexes

The Bottom Line

Trading candlesticks like the dark cloud cover needs strict discipline and emotion-free trading. Candlestick trading is a part of technical analysis and success rate may vary depending upon the type of stock selected and the overall market conditions. Use of proper stop-loss, profit level and capital management is advised.
One can also explore the similar candlestick formations on various dates using the below screener:

Search Dark Cloud Cover Candles for a particular: