Many traders consider the dark cloud cover pattern important as a possible signal of reversal to the downside. It is not thought to be as strong a signal as the more definitive bearish engulfing pattern. Nonetheless, dark cloud cover 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, its significance is considerably reduced.
The dark cloud cover forms as follows:
- The first candlestick is a white/green candle with a long real body.
- The next candle gaps higher, but then turns black/red and closes in the lower half of the body of the preceding candle.
The fact that this candle opens higher, but erases more than half of the previous candle's gain, 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 third candle in the sequence closes below the low of the first candle. From that point, price may steadily fall 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:
- The bodies of both the initial candle and the dark cloud cover candle are very long.
- The higher the opening gap up by the dark cloud cover candle, the more marked the reversal downward.
- The pattern occurs near a major resistance level, especially if the gap up is over the resistance level, but the candle's eventual close is below the resistance level.
- There is a high volume of trading during the formation of both candles.