Dark Cloud Cover | Bearish Piercing Line

day 1 bullish candlestick, gap up 2nd bearish candlestick

The Dark Cloud Cover or Bearish Piercing Line is a trend reversal pattern that occurs at the top of an uptrend or congestion band. The candlestick on the first day is a long bullish candlestick and the second candlestick is long bearish candlestick. The second day candlestick opens above the previous day’s high and ends up closing within the price range of the previous day’s real body. A less strict definition suggests that the second day candle can open above the previous day’s close rather than its high. According to Nison’s (1991, p. 44) research, many technical analysts require the bearish candlestick to penetrate and close more than 50% into the previous day’s real body. For those familiar with the bearish engulfing pattern, the bearish piercing line is essentially an incomplete bearish engulfing pattern, since a bearish engulfing pattern’s second day bearish candlestick penetrates and closes more than 100% past the real body of the first day’s bullish candlestick.

Psychology of Bearish Piercing Line

gap up on second day candlestick is rejected

The market psychology of the bearish piercing line is explained next. The market is moving upwards when a large bullish candle appears making a new high. The next day the price gaps upward making yet another new high, so far the bulls have been completely in charge. However, instead of the price continuing to go higher, the price begins to sell off and sells off so much that it ends up eliminating over half of the gains of the bullish candle on the previous day. Essentially the new highs of the past uptrend have been rejected, the bears have had enough.

Traits Increasing Dark Cloud Cover Candlestick Pattern

further 2nd day penetrates 1st day the more bearish

Traits that increase a Dark Cloud Cover’s importance is given below (Nison, 1991, p. 44):

  • The greater the penetration of the second day’s bearish candlestick into the price levels of the first day’s bullish candlestick, the “greater the chance for a top”.
    Reason: By viewing the second day’s bearish candle as a rejection of the first day’s bullish candle, the more the second day’s bearish candlestick penetrates into the price levels of the first day’s bullish candlestick the more powerful the bears are showing themselves to be. 50% is a half rejection of the bulls, 100% is a complete rejection of the bulls, thus the higher the percentage of penetration the stronger the bears rejection of the current upward trend.
  • A major resistance area is penetrated when the second day opens above the resistance area but then prices fall and close below the resistance area.
    Reason: A failed breakout above resistance is a sign to the bulls that they have failed and the confirmation that the resistance is still intact gives confidence to the bears who will now begin selling.
  • High volume accompanies the second day bearish candlestick’s opening.
    Reason: If there is large volume on the opening after a gap up from the prior day, there are many traders who are now long. When the prices start moving downward, the many traders who are long are now in trouble and might begin to sell.

A dark cloud cover pattern is voided if a future candlestick closes above the high of the dark cloud cover pattern.

When shorting based on the dark cloud cover, Nison (1994, p. 71) suggests placing a stop loss order at the highs of the dark cloud cover formation. In contrast, if prices rise above the highs of a dark cloud cover pattern, he suggests to buy the breakout since the pattern has been voided and the prior uptrend is now continuing.

Dark Cloud Cover Blended Candle = Shooting Star

blended dark cloud cover equals shooting star

When the two candlestick dark cloud cover pattern is combined (open of first day and close of second day) into a single candlestick it is a shooting star candlestick that is interpreted as bearish.

Dark Cloud Cover Candlestick Chart Example

candlestick chart of dark cloud cover candle pattern

A very good example of a dark cloud cover pattern is shown above of the Healthcare SPDR ETF (XLV). Previous to the dark cloud cover, the trend is up for over a month. The first day of the bearish piercing pattern is a long bullish candlestick that closed creating yet another new high for the uptrend. The next day, which is the second day of the bearish piercing pattern, opened above the high of the first day. This is yet another new high for the uptrend. Nevertheless, after the opening high, the price retreated throughout the day penetrating about two-thirds of the way down into the first day bullish candle’s prices. From there, a month long downtrend commenced.

Dark Cloud Cover Confirms Resistance

dark cloud cover establishing future resistance

A few weeks prior to the bearish piercing pattern, the Energy SPDR ETF (XLE) established an area of resistance, shown on the chart above as a blue line. As is typical for the setup of the dark cloud cover pattern, an uptrend occurred that contained a bullish candlestick that made a new high for the recent uptrend; however the bullish candlestick did not exceed the area of resistance. The next day, the second day of a dark cloud cover pattern, gapped higher and proceeded to attack the overhead resistance. But the bulls failed to exceed the overhead resistance. Bears were able to eliminate about 85% of the prior days bullish candlestick real body gains. The day following the bearish piercing pattern confirmed the bearish sentiment even more by gapping down with three more bearish candles making new lows.

Works Referenced

  1. Nison, S. (2003) The Candlestick Course. Hoboken: John Wiley & Sons.
  2. Nison, S. (1994) Beyond Candlesticks: New Japanese Charting Techniques Revealed. New York: John Wiley & Sons.
  3. Nison, S. (1991) Japanese Candlestick Charting Techniques. New York: New York Institute of Finance.
  4. Rhoads, R. (2008) Candlestick Charting For Dummies. Hoboken: Wiley Publishing.
  5. ThinkorSwim. (2011). ThinkorSwim Resource Center: Candlestick Patterns Library.