How to predict market weather when the dark cloud cover appears

The dark could cover pattern is another member of the Japanese candlestick family and indicates possible trend reversal after a continuous upward rise. It appears in an uptrend – a bullish green candle is followed by a red bearish one, which forms in an uptrend but closes below the midpoint of the green candle.

The dark cloud pattern is a forex candlestick and used by traders to spot a probable trend reversal.

Candlesticks charts are widely used in forex as they are in equity trading. The forex candlestick charts are used to provide a range of information regarding forex price movement, helping traders to form effective trading strategies. These lies halfway between traditional bar charts and more advanced ‘Renko’ charts.

How to spot a dark cloud cover in candlestick charts

Dark cloud cover is a bearish candlestick pattern that appears in the chart to indicate a trend reversal. It is quite easy to spot, but if you are a new investor, you’ll need some practice before you successfully identify different candlestick formations.

Two candles group together to form a dark cloud cover pattern – one green candle that is a part of the prevailing upward trend, and a red bearish candle that although forms in the uptrend, closes below the midpoint of the previous candle. It is a potential indication of a trend reversal. However, traders need to confirm it with other trading tools before taking a position.

Important points to remember

  • Dark cloud cover candlestick pattern appears in an uptrend, a potential indication of a trend reversal
  • It is a combination of a bullish green candle and a red bearish candle, where the red candle closes below the midpoint of the green candle
  • The bearish candle opens higher than the green candle – the difference between the closing price of the first candle and the opening price of the second one is called market gap
  • Both candles have large real-bodies and short or no shadows, indicative of strong participation from traders
  • A third short bearish candle appears after the red candle, called the confirmation
  • It indicates a shift in momentum, but traders must confirm its prediction with other trading tools

What does a dark cloud cover tell you?

The larges bearish candle appears in an uptrend, opens above the previous bullish candle. This indicates that initially, buyers controlled the market and pushed it higher before bearish forces took over and ultimately, the price closes below the midpoint of the bullish green candle. Since it is a bearish indicator, it is valid if only appear in an uptrend. Moreover, the formed candles must have large bodies. Short bodied candles are often ignored as they aren’t potentially strong enough to drive a change in momentum. And thirdly, the pattern is more significant when the bearish candle closes below the midpoint of the green candle, preferably with no shadows.

The pattern appearing in an uptrend is more reliable than when similar formations appear during a choppy market. When it appears, traders exit the long position and enter short for the better risk-reward situation. However, they might wait for confirmation, which is a brief red candle appearing next to the dark could cover pattern.

Candlestick patterns are visual patterns, which means there is no calculation involved. To plan an exit, traders, therefore, need to rely on other technical trading tools. Sometimes they place a stop-loss above the high of the bearish candle. Secondly, they can look at the relative strength index (RSI) momentum oscillator. RSI over 70 is an indication of overbuying after which the market may fall. A breakdown from a key support level after a dark cloud cover also signifies the onset of a downtrend.

Conclusion

There are various ways to confirm if a dark cloud cover formation is a potential sign of downtrend or not. Traders often use it in conjunction with other technical trading tools like support and resistance lines, trendlines, and stochastic oscillator for confirmation. Traders who want to exit their long position may consider exiting at the end of the bearish candle or the following day. Similarly, traders planning to enter around this time can place their stop-loss above the higher point of the bearish candle.