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Trading The Dark Cloud Cover Candlestick Pattern

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The dark cloud cover candlestick pattern is often referred to as a reversal pattern and some proponents of the dark cloud cover suggest you can catch the top of an uptrend and be in on the down move at certain points on the chart.

That is an oversimplification of the dark cloud cover pattern as there are other candlesticks, such as pin bar candlesticks or bearish engulfing candlesticks, that prove out better in testing.

The dark cloud cover can be a reversal candlestick pattern when taken in context with the overall trend of the market, namely a downtrend.

In a downtrend, trading a rally back to the downside is a trading strategy that actually has an edge.  Using the reversal power of the dark cloud cover candlestick, we would wait until a rally in a downtrend is underway.

At certain points in the chart such as resistance level, a moving average, or even a Fibonacci level, price will, if the trend stays intact, resume back to the downside.

We want to see a reversal candlestick pattern emerge at these price zones and one reversal pattern to consider is the dark cloud cover pattern.


What Is A Dark Cloud Cover Pattern

Given that we are looking at a pattern and this is a bearish reversal pattern, we need to have at least two candlesticks to have a dark cloud cover form.  Trading wisdom suggests trying to pick market tops with this candlestick pattern, but we are going to do it in a manner consistent with conservative trading protocols.

Thinking you are going to catch a major trend change is a quick path to the poor house.  The path of least resistance is to trade with the money flow – not the hopes of a change of money flow.

We want to consider a few things:

  • An uptrend has ended via an exhaustion pattern or momentum move against the trend
  • We could consider a market that is overextended and we expect a substantial correction and not a full change in trend
  • Price is involved in a rally against the down trend in price

After the conditions are met, we want to see a candlestick form at certain locations on the chart that fits the following criteria:

  1. Price is moving upwards
  2. A candlestick opens up past the previous day closing price – gap up in price
  3. This candlestick reverses and closes past the midpoint of the previous candlestick

You can see that the reversal candle opened higher than the last green candle but ended up closing and covering more than 50% of the previous candle.  Traders that know reversal candlesticks probably see that this dark cloud cover pattern is the beginning formation of a bearish engulfing candlestick.  We just need the entire candlestick covered although some argue just the real body.

At the end, we are looking at the same thing….supply overwhelming demand – although in Forex, price fluctuations have more do with interest rates, news, economic health…etc…of the different countries.

Also keep in mind that dark cloud covers need a gap open in price and due to the nature of Forex, it can be difficult finding this reversal pattern because there is no official open/close time which makes gaps not as common.


Dark Cloud Cover Reversal In A Down Trend

As mentioned, we are going to toss the usual trading wisdom aside (because it is rarely correct – most losing traders follow conventional thinking) and look at a market that has come off an uptrend and is forming a rally in price.

  1. After a long run in price, we see a bearish engulfing candlestick (momentum) slam price into a trading range.
  2. The trend line that shows an uptrend is broken and price begins making lower highs and lows (down trending price action)
  3. After a rally in price to resistance, a reversal candlestick forms – dark cloud cover – and we can look to short


How To Trade Dark Cloud Cover Candlestick Patterns

Think about what happens in the formation:

  1. We get a gap in price upwards which is a bullish move giving the bulls hope that price will continue up
  2. Price slams back down and eats up over 50% of the previous candlestick which shows a change in sentiment.
  3. Those holding long positions, thinking the gap meant higher prices, get discouraged when the closing price is lower than the previous two opens

To me, a dark cloud cover shows momentum to the downside and my trading plan has a momentum variable built in.  With true momentum in a bearish context, I want to get short as soon as possible to catch the possible increase in momentum such as we see on this chart.

Entry Zone

– Traders can place a pending order to short below the dark cloud cover or for confirmation, below the low of the first candlestick of the pattern

Stop Location

– Using “object in motion tend to stay in motion” , placing your stop loss over the pivot area is wise because if this reversal fails, it will fail when price breaks the highs of the pattern.

Price Targets

– There are many methods to taking profits including a risk multiple or pattern measures.

This charts shows an example of an A-B = C-D price target where the first leg of the swing distance is projected down to come up with a rough target

Price Target
Price Target

This short in Netflix as an example gave a profit of $23.10 per share and a 1.97 RR ratio before price rallied back to the upside.


In Summary

Due to the lack of this reversal pattern in markets like Forex, traders should keep this in their toolkit but also consider more common candlestick reversal patterns.

You may read that the dark cloud cover is good to pick market tops, that is false.  Traders would be better served looking for signs of exhaustion of the uptrend and look for this pattern during a rally in price to take another trade short.

In my weekly free Forex setups, I rarely show picking the top of the market.  That is a fools game. I do often show how we can enjoy the momentum created by a trend reversal to get on board for another leg down depending on the context of the market.

Like all reversal patterns, the dark cloud cover is a guarantee of nothing.  Ensure proper risk and money management at all times.


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