Inside a Dark Cloud Cover

May 3, 2008: 11:58 AM CST

With Candlestick analysis becoming more popular and accepted, I thought it would be interesting to take you inside a Dark Cloud Cover candle pattern. Let’s peek inside the candle.

I mentioned that Google recently formed a Dark Cloud Cover pattern. Let’s discuss it before we see it.

A “DCC” is a reversal pattern that must have a prior uptrend to confirm its existence (it must have something to reverse!).

Further, there must be an overnight up-gap which is indicative of a short-term buying climax that exhausts demand.

Third, the price must reverse, fill the gap, and then continue its trek downwards.

Finally, the intraday price action must retrace at least 50% of yesterday’s range.

Those are the rules for determining what a “DCC” is.

Factors that increase its potential predictive value:

If volume is light on the first candle and strong/heavy on the second;

If the gap up is noticeably high yet is still filled;

If the second candle closes deeply (but not 100%) into the first candle (if it closed beneath yesterday’s range, it would be a more powerful “Bearish Engulfing” pattern)

Let’s look at the ideal pattern:

The green/red lines represent idealized intraday price action that form the two daily candles.  The dotted line divides the two days’ price action.

Now, let’s look at an actual example I mentioned previously in Google (GOOG):

We can see that the recent Google price action almost formed a bearish engulfing pattern, but because price closed above yesterday’s open (but greater than 50% of yesterday’s range), the pattern is the ominous sounding “Dark Cloud Cover.”

Understanding the psychology and construction of famous candlestick patterns can help you make more informed decisions as you analyze the struggle between buyers and sellers and what certain candle patterns may mean for the near-term price action in a stock.

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