The dark cloud cover pattern is important for traders as a possible signal of market reversal to the downside. It is not considered as strong a signal as the more definitive bearish engulfing candlestick formation but, nonetheless, it is important to note as a potential bearish indicator, especially if it forms on a higher time frame chart, such as a daily chart. On lower time frames, the significance of a dark cloud cover is considerably reduced.
The dark cloud cover forms as follows: The previous candlestick appears very bullish with a long body that closes to the upside. The next candle gaps to an even higher price level at its open, but then the price falls back so the candle closes in the lower half of the body of the preceding up candle. The fact that the candle opens higher, but then closes by erasing more than half of the previous candle's gains, is what gives it a bearish character and also its name. The candle opens "sunny," but then "dark clouds move in." The bearish indication of the dark cloud cover is strengthened if the candle that follows it closes below the low of the up candle that immediately preceded it. From that point, price may proceed steadily downward without significant upward retracement for some time.
Traders evaluate the significance of the dark cloud cover as being increased by any of the following factors:
- After exercising a put option, can I still hold my option contract in order to sell it at a lower price?
- Are Stocks With Large Daily Volume Less Volatile?
- Are We In A Bull Market Or A Bear Market?
- Can a stock lose all its value? How would this affect a long or short position?
- Can a stop-loss order protect a short sale?