Importance of Dark Cloud Cover Pattern

Our next reversal pattern is the dark-cloud cover (see below image). It is a two candlestick pattern that is a top reversal after a uptrend or. at times. at the top of a congestion band. The first day of this two candlestick pattern is a strong white real body. The second clay’s price opens above the prior session’s high (that is. above the top ‘ the upper shadow). 

However, by the end the second day’s session. the market closes near the low of the day and well within the prior day’s white body. The greater the degree of penetration into the white real body the more likely a top will occur. Some Japanese technicians require more than a 50% penetration of the black session’s close into the white real body. fi’ the black candlestick does not close below the halfway point of the white candles tick it may be best to wait for more bearish confirmation following the dark cloud cover. 

The rationale behind this bearish pattern is readily explained. The market is in an uptrend. A strong white candlestick is followed by a gap higher on the next session’s opening. Thus far the bulls are in complete control. But then no continuation of the rally occurs! In fact, the market closes at or near the lows of the day moving well within the prior day’s real body. In such a scenario the longs will have second thoughts about their position. Those who were waiting for selling short now have a benchmark to place a stop—at the new high of the second day of the dark-cloud cover pattern.

The following is a list of some factors that intensify the importance of dark-cloud covers:

1. The greater the degree of penetration the black real body’s close into (lie prior white real body. the greater the chance for a top. If (lie black real body covers the prior clay’s entire white body. a bearish engulfing pattern would occur. The dark-cloud cover’s black real body only gets partially into the white body. Think (lie dark-cloud cover as a partial solar eclipse blocking out part. The bearish engulfing pattern can be viewed as a total solar eclipse blocking out (lie entire sun (that is. covers (lie entire white body). A bearish engulfing pattern. consequently. is a more meaningful top reversal. If a long, white real body closes above the highs ‘ (lie dark-cloud cover, or the bearish engulfing pattern, it could presage another rally.

 2. During a prolonged uptrend, there is a strong white clay which opens on its low (that is a shaven bottom) and closes on its high (that is. a shaven head) and the next day reveals a long black real body day. opening on its high and closing on its low, then a shaven head and shaven bottom black day have occurred. 

3. the second body (that is the black body) of the dark-cloud cover opens above a major resistance level and then fails, it would prove the bulls were unable to take control of the market. 

4. It on the opening of the second day there is very heavy volume, a buying blow off could have occurred. For example. heavy volume at a new opening high could mean that many new buyers have decided to jump aboard ship. Then the market sells offs. It probably won’t be too long before this multitude of new longs (and old longs who have ridden the uptrend) realise that the ship they jumped onto is the Titanic. For futures traders. very high opening interest can be another warning.

HAMMER AND HANGING-MAN LINES

Figure shows candlesticks with long lower shadows and small real bodies. The real bodies are near the top 1 the daily range. The variety ± candlestick lines shown in the exhibit are fascinating iii that either line can be bullish or bearish depending on where they appear in a trend. if either of these lines emerges during a downtrend it is a signal that the downtrend should end. In such a scenario. this line is labelled a hammer.

as in “the market is hammering out” a base. See Exhibit 4.5. Interestingly. the accrual Japanese word for this line is takuri. This word means something to the affect Cf “trying to gauge the depth Cf the water by feeling for its bottom.”
if either Cf the lines in Exhibit 4.4 emerge after a rally it tells you that the prior move may be ending. Such a line is ominously called a hanging man (see Exhibit 4.6). The name hanging man is derived from the fact that it looks like a hanging man with dangling legs.

It may seem unusual that the same candlestick line can be both bullish and bearish. Yet. for those familiar with Western island tops and island bottoms you will recognise that the identical idea applies here. The island formation is either bullish or bearish depending on where it is in a trend. An island after a prolonged uptrend is bearish, while the same island pattern after a downtrend is bullish.

The hammer and hanging man can be recognised by three criteria:

1. The real body is at the upper end of the trading range. The colour Cf the real body is not important.
2. A long lower shadow should be twice the height Cf the real body
3. It should have no. or a very short. upper shadow.

The longer the lower shadow. the shorter the upper shadow and the smaller the real body the more meaningful the bullish hammer or bearish hanging man. Although the real body the hammer or hanging man can be white or black. it is slightly more bullish if the real body c the hammer is white. and slightly more bearish if the real body c( the hanging man is black. if’ a hammer has a white real body it means the market sold off sharply during the session and then bounced back to close at. or near. the session’s high. This could have bullish ramifications if’ a hanging man has a black real body. it shows that the close could not get back to the opening price level. This could have potentially bearish implications. 

It is especially important that you wait for bearish confirmation with the hanging man. The logic for this has to do with how the hanging-man line is generated. Usually in this kind of scenario the market is full of bullish energy. Then the hanging man appears. On the hanging-man day. the market opens at or near the highs. then sharply sells off and then rallies to close at or near the highs. This might not be the type of price action that would let you think the hanging man could be a top reversal. But this type of price action now shows once the market starts to sell off. it has become vulnerable to a fast break. 

the market opens lower the next day. those who bought on the open or close of the hanging—man day are now left “hanging” with a losing position. Thus the general principle for the hanging man: the greater the down gap between the real body of the hanging-man day and the opening the next day the more likely the hanging man will be a top. Another bearish verification could be a black real body session with a lower close than the hanging-man sessions close.