A dark cloud cover pattern is a candlestick pattern used in technical analysis to identify the peak of upward price trends, but what does it look like? This pattern typically appears on a stock that has had a recent upward trend with a gap up that is sold off and closes below the previous days close.
It gets its name from the way the large red candlestick hangs over the peak of an upward price trend like a “dark cloud”, and was originally coined as a term when candlestick charts were white and black instead of green and red.
Dark Cloud Cover Pattern Example
An example of a dark cloud cover pattern would be a stock that opens at 10$, above its previous day’s close of $9.50, trades as high as $10.50 at one point, but then closes at $9 at the end of the day. This would create a large red candlestick that hangs above the previous uptrend of the past few days or weeks.
If the trend reversal was confirmed, then the dark cloud cover pattern would be complete, as the large red candlestick would be at the peak of the uptrend and following downtrend.
Trading with a Dark Cloud Cover Pattern
The dark cloud cover pattern is an excellent tool for traders because of how easy it is to spot with just a simple visual scan of candlestick charts. This is why this pattern is most often used as an initial indicator to identify potential trades.
Traders will scan a number of candlestick charts for relevant securities, and then select those with potential for the next or subsequent trading days by using indicators such as the dark cloud cover pattern. The traders will then use further analysis to confirm that a trend reversal is likely to follow and develop a corresponding trading strategy for that security.
When you enter this type of setup you want to use the high as your stop with profit targets based on your 2:1 risk/reward ratio. So if you are risking 50 cents, then you shouldn’t take profits until you are up a dollar.
Indicators such as the dark cloud cover pattern are most often used in trend or momentum trading, which is one of the most popular strategies in contemporary day trading. Correctly identifying trends allows day traders to employ a number of highly effective and profitable day trading strategies with the relative confidence that they know that the price will continue on its trend for the next few days at least.
As with any rough initial indicator, the dark cloud cover pattern should only be used in conjunction with a number of additional complementary indicators and further analysis, including a review of relevant news and information or fundamental analysis of a stock’s financial reports.
The dark cloud cover pattern is an excellent technical analysis indicator for quickly identifying potential reversals on upward trends. Day traders who follow momentum or trend trading strategies will use this pattern and similar technical analysis indicators to identify potential trends and trend reversals, and then employ a variety of highly effective trading techniques to profit from following these trends.
However, the dark cloud cover pattern should only be used in conjunction with other complementary indicators and additional alternative forms of analysis.