Dark Cloud Cover

The next reversal pattern is called a curtain of dark clouds.(See Figure 4.24). It also consists of two candles, occurs after an uptrend or at the upper border of the side corridor and is a reversal signal at the top. On the first day, a candle with a long white body forms on the chart, and on the second day, trades open above the previous daily range (i.e., the opening price exceeds the upper shadow of the first candle). However, the second session ends with a decline to the area of ​​the daily low, which should be within the boundaries of the previous white body. The stronger the black candle overlaps the white one, the higher the probability of a reversal. Some Japanese analysts believe that at least half of the white body should be covered in this way. If this does not happen, then it is probably worth waiting for additional confirmation of the dark cloud cover bearish signal.

The reasons for the bearish nature of this pattern are quite understandable. It forms during an uptrend, when the bulls are in complete control: a convincing white candle appears on the chart, and the next trade starts with a gap up. But here the rally is interrupted, and moreover, the session ends near or at the level of the daily low, which lies well below the previous closing price. After that, long position holders will have to think twice about whether they should keep their portfolios. And for those who have been waiting for the right moment to open short positions, there is a good reference point for setting stop orders - this is the maximum price of the second candle in the “veil of dark clouds” pattern. Here are the factors that, when this pattern appears, reinforce its bearish nature: 1. The stronger the body of the black candlestick overlaps the body of the white one, the higher the probability of a top formation. Note that a full overlap will form a bearish engulfing pattern. A dark cloud cover can be compared to a partial solar eclipse, while an engulfing pattern can be compared to a total one, hence the latter is a stronger reversal signal. But if a long white candlestick appears on the chart after that, with the closing price exceeding the highs of the dark cloud curtain or a bearish engulfing pattern, this may indicate a continuation of the rally. 2. The bearish signal is more pronounced if the curtain of dark clouds is formed after a long uptrend, and at the same time, both candles included in it have no upper and lower shadows. That is, for a white candlestick, the opening price is at the level of the daily low, the closing price is at the daily high, and for the black candlestick, the opening price corresponds to the maximum mark for the day, and the closing price - to the minimum. 3. If the black cloud curtain candle opens above an important resistance level and closes below it, then the bulls are unable to control the market. 4. A large volume of trading during the opening of the market on the second day additionally signals that the rise in quotes may end quickly. Let us assume that prices begin to fall as soon as a large number of new buyers have boarded the ship. It won't be long before they realize they're on board the Titanic. Surely they will begin to close positions - like those who bought earlier and managed to participate in the rally. At the same time, a significant increase in open interest should serve as an additional bearish signal for futures traders. Figure 4.25 shows the difference between a dark cloud cover and a bearish engulfing pattern. Two candles that appeared in June 1989 form a curtain of dark clouds: a candle with a long white body is followed by a candle with a long black body, which originates from a new local maximum and ends near a weekly low, covering a significant part of the white body. After the formation of a curtain of dark clouds, the market growth stopped, but the real decline began a few more weeks later, when a bearish engulfing pattern materialized. If in the first case the overlap of the candles was partial, then in the second case it was complete.

In Figure 4.26, you will find three dark cloud covers, all of which are confirmed by other bearish signals. Let's consider each of them separately. 1. Pattern 1 is slightly different from the ideal dark cloud cover, as it has a blackbody open that matches the previous day's high, rather than exceeding it. This was only a warning signal, which nevertheless should be considered as a negative factor. This model, in addition, speaks of an unsuccessful attempt by the bulls to break through the resistance at the level of the February highs. 2. In this case, besides the veil of dark clouds, there was another reason to pay special attention to the $21 mark. One of the axioms of technical analysis says that a broken support level often becomes resistance in the future. Support in the $21 area was broken on March 9, and now this is where the resistance level is. The market tested it in the early days of April, forming a curtain of dark clouds (we will return to the topic of support and resistance interchangeability in Chapter 11). 3. The formation of this model was also accompanied by an unsuccessful attempt to overcome the resistance level set by price highs at the end of April. In all of these examples, a bearish curtain of dark clouds appeared on the chart near the resistance levels. It is very useful to use an approach in which various technical indicators confirm each other. This is exactly the tactic that the second part of this book will be devoted to, where the combined use of Japanese candlesticks and other technical analysis tools is discussed in detail.

In Figure 4.27, dark cloud cover 1 interrupted a two-week rally in early March, and the correction continued for a week. Later in April, two more curtains of dark clouds formed, the first warning that the previous two days' sharp rise was likely to be over, and the second warning a pronounced bearish trend. It is no coincidence that it turned out to be the strongest negative signal, given the psychology of the market at the time of its appearance. As noted above, the bearish nature of the dark cloud cover is due to the second day opening at a new high and closing well below the previous day's highs. What happens if, on the second day, the opening price breaks records not just of the last days or weeks, but of several months, but cannot stay at the achieved level? This will be an extremely negative signal, which happened in this case. Dark Cloud Veil black candle 3 opened higher than the highs of at least the last three months, then the market went down, and by the end of the day most of the white body was covered by black.

In Figure 4.28, the price increase that began on February 10 came to an abrupt halt with the appearance of a dark cloud cover in the middle of the month.