Dark Cloud Cover

The dark cloud cover is a two-bar bearish reversal Japanese candlestick pattern that is best traded using a mean reversion strategy according to extensive backtesting.

If you’re a traditional candlestick technical analyst, you might be surprised that you should have been going bull when you’ve been going bear.

Keep reading if using history as a guide to determine the best dark cloud cover trading strategy excites you.

What Is a Dark Cloud Cover Candlestick Pattern?

Dark Cloud Cover Candlestick Pattern Illustration © Analyzing Alpha
Dark Cloud Cover Candlestick Pattern Illustration

The dark cloud cover is a two-candle pattern that supposedly signals a bearish reversal.

The dark cloud cover gets its name from the ominous second black candlestick.

However, as we’ll soon see, this candlestick isn’t so scary.

But before we cover the best dark cloud cover trading strategies, let’s learn how to identify this pattern on our candlestick charts.

How to Identify the Dark Cloud Cover Candlestick Pattern

Dark Cloud Cover Candlestick Pattern on the December 13th, 2021 daily chart
Dark Cloud Cover Candlestick Pattern on the December 13th, 2021 daily chart

The following are the requirements for a valid dark cloud cover pattern:

  • The first candle must be a long bullish candle.
  • The second candle must open above the prior candle’s high, and close within the first candle’s real body, ideally below the midpoint.
  • The dark cloud cover must occur during an uptrend.

We see the dark cloud cover candlestick pattern on the Apple (AAPL) daily chart on December 13th, 2021.

Price is in a bullish trend as it’s above the fifty-day moving average. The first candlestick is bullish with a large long real body. The second candlestick opens above the prior high and closes below the midpoint of the preceding candlestick completing the pattern.

Now that we know how to identify the dark cloud cover, how do we profit from these two candlesticks?

How to Trade the Dark Cloud Cover Candlestick Pattern

The dark cloud cover should be traded using a bullish mean reversion strategy in the forex and stock market. Data-driven traders should pass on trading this pattern in the crypto markets as there are insufficient data to determine statistically significant trading setups.

But before we learn how to optimize the dark cloud cover, let’s gain context and understand how to trade it traditionally.

Dark Cloud Cover Bearish Reversal Trade Setup

Dark Cloud Cover Bearish Reversal Trade Setup on the Microsoft (MSFT) February 11th, 2020 daily chart
Dark Cloud Cover Bearish Reversal Trade Setup on the Microsoft (MSFT) February 11th, 2020 daily chart

We can see the dark cloud cover pattern occurring on the Microsoft (MSFT) daily chart on February 11th, 2020.

The existing trend is bullish, as determined by the fifty-day moving average. The first day is an up candle bullish marubozu. The second day opens above the first candle’s high and is a black down candlestick.

With the signal set, traditional traders short at a break of the first candle’s low and set a stop loss above the first candle’s high.

In our Microsoft example, traders would have gone short the next day when the bearish candlestick moved past the previous day’s low. This pattern would have produced profits for these traditional traders, but on average, trading this pattern bearish would lose you money over time.

So how do we trade this pattern optimally using history as our guide?

Dark Cloud Cover Bullish Mean Reversion Trade Setup

Dark Cloud Cover Bullish Mean Reversion Trade setup on the Markel (MKL) November 11th, 2020 daily chart
Dark Cloud Cover Bullish Mean Reversion Trade setup on the Markel (MKL) November 11th, 2020 daily chart

Price is in an uptrend as it’s above the fifty-day simple. We see a long bullish candle followed by a gap up and bearish candle that closes below the midpoint of the first candle.

With the pattern identified, smart forex and stock traders enter when the price crosses below and back above the pattern low, setting a stop loss of one ATR.

Let’s shine a light on this strategy using the Markel example above.

The pattern low occurs on the first bullish candle at $1,016.72. The price moves below and back above this price on the 12th, triggering an entry. A savvy trader would have taken profits on the 16th, making a handsome profit.

Speaking of profits, what does history say about the best dark cloud cover trading strategy?

Does the Dark Cloud Cover Candlestick Pattern Work? (Backtest Results)

Using the following rules, I backtested the dark cloud cover pattern on the daily timeframe in the crypto, forex, and stock markets.

  • A close above the 50-day SMA constitutes an uptrend.
  • I tested risk-reward ranges from 1 to 5.
  • The optimal risk-reward ratio is selected using profit per bar.
  • Entry and exits are discussed in the how-to trade section above.
  • Confirmation must occur within three days of the pattern signal.

Similar Candlestick Patterns

Multiple candlestick patterns are often confused with the dark cloud cover. It’s essential to understand the differences when using candlestick pattern technical analysis.

Bearish Engulfing vs. Dark Cloud Cover

Bearish Engulfing Candlestick Pattern Illustration ©Analyzing Alpha
Bearish Engulfing Candlestick Pattern Illustration

The bearish engulfing candlestick pattern is a two-bar bearish reversal pattern similar to the dark cloud cover. The only difference between the bearish engulfing and the dark cloud cover is that the bearish engulfing pattern engulfs the previous candle. In contrast, the dark cloud cover gaps up and closes with the last candle’s body.

Piercing Line vs. Dark Cloud Cover

Piercing Candlestick Pattern Illustration © Analyzing Alpha
Piercing Candlestick Pattern Illustration

The piercing line candlestick pattern is the mirror opposite of the dark cloud cover. The piercing line is a two-bar bullish reversal pattern whose first candle is bearish, followed by a bullish candle that gaps down and closes past the prior midrange. In contrast, as we just saw, the dark cloud cover has a bullish candle followed by a bearish candle that gaps up.

The Bottom Line

The dark cloud cover’s sizeable black candle isn’t an ominous warning to traders – according to history, this supposed price reversal pattern simply means there’s likely volatility before likely resuming the prior trend.

Instead of guessing, check out the backtest results to only trade the most accurate candlestick patterns.

Leave a Comment