Dark cloud covering markets? What you must know about this chart pattern

A fundamental change in a company’s outlook or a reversal in the overall market mood may have a meaningful bearing on the way a particular stock behaves in the market. Technically, any reversal in an uptrend is known as a ‘bearish reversal trend’, which indicates that the trend may reverse and the price may start falling.

While technical analysts read different bearish reversal candlestick patterns to gauge any scrip’s trajectory, one of the patterns is a ‘Dark Cloud Cover’. This pattern indicates a negative sentiment in the stock which, if met with follow-up selling, can aggravate the negative sentiment further. 

In this pattern, the bearish candle opens above the close of the prior candle, and closes below the midpoint of the candle. This formation illustrates that while the stock opened with a strong bullish sentiment, it failed to hold the upward momentum. Furthermore, a close below the midpoint suggests that bears are getting hold of the negative trend and may continue to dominate. CLICK HERE FOR THE CHART

Generally, short sellers tend to become active in the market as soon as selling pressure intensifies. Therefore, formation of a Dark Cloud Cover on a technical chart may result in a bigger and wider correction if the stock fails to regain strength in subsequent sessions. The said formation enables investors and traders to look for opportunities to book profits and endure calculated risk in long positions. If the stock conquers the high of the Dark Cloud Cover, the pattern is said to disprove the view. This level acts as stop loss for technical trading.

Although this formation seems rare, it may provide valuable information to investors in a downward trending scenario.

 Key aspects of a Dark cloud cover

·         The highest confirmation arrives at the top of the bullish trend.

·         Both, prior green candle and dark cloud cover candle, need to have bigger bodies.

·         It is a trend reversal pattern and is not considered as a healthy correction indicator.

·         The stock needs to open above the prior candle.

·         A closing below the midpoint clearly confirms underlying weakness.

·         The significance of this pattern is more relevant when it bears strong volumes

The formation of a Dark Cloud Cover is confirmed when the immediate candle after the Dark Cloud Cover closes below the low of the first–green candle. This suggests that the weakness witnessed further selling pressure and, thus, the stock continues to hold the negative bias.

Furthermore, whenever this pattern is supported with other major technical indicators like Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), Stochastic, etc the trend is said to attain further confirmation. A negative crossover of RSI -- trading in overbought condition -- indicates that the strength in the stock is getting weaker. Similarly, when the MACD falls towards the zero line, the direction is said to be in a negative momentum.

The Dark Cloud Cover pattern is usually recognized across longer time frames such as on daily, weekly and monthly charts. Its relevance during intra-day trading, say during 5/15/30/60-minute trade is not significant as lower time frames have higher volatility and may reflect whipsaw trades.

Lastly, while the minimum downside is expected to be near the last reversal of the uptrend, the weakness may exaggerate and drive the stock price towards lower levels if it does not hold the support.