Common Mistakes to Avoid when Trading the Dark Cloud Cover Pattern

DARK CLOUD COVER

DARK CLOUD COVER Description

The Dark Cloud Cover in Figure 2.31 is the bearish counterpart to the Piercing Pattern. The first day of the pattern is a long white candle at the top end of a trend. The second day's open is higher that the high of the previous day. It closes at least one-half way down the previous day candle, the further down the white candle, the more convincing the reversal. Remember that a close at or below the previous day's open turns this pattern into a Bearish Engulfing Pattern. Kabuse means to get covered or to hang over.

Criteria

• The body of the first candle is white; the body of the second candle is black.
• The uptrend has been evident for a good period. A long white candle occurs at the top of the trend.
• The second day opens higher than the trading of the prior day.
• The black candle closes more than halfway down the white candle.

Signal Enhancements

• The longer the white candle and the black candle, the more forceful the reversal.
• A higher the gap up from the previous days close, the more pronounced the reversal.
• The lower the black candle closes into the white candle, the stronger the reversal.
• Large volume during these two trading days is a significant confirmation.

Pattern Psychology

After a strong uptrend has been in effect, the atmosphere is bullish. Exuberance sets in. They gap the price up. The bears start to show up and push the price back down. It finally closes at or near the lows for the day. The close has negated most of the previous day's gains. The bulls are now concerned. They obviously see that the uptrend may have stopped. This signal makes for a good short, with a stop being the high of the black candle day. Notice that if the Dark Cloud Cover were to close lower, below the open of the previous day, it becomes a Bearish Engulfing pattern. The bearish Engulfing Pattern has slightly stronger bearish implications. (See Figure 2.32.)

HARAMI

BULLISH HARAMI Description

The Harami is an often seen formation. The pattern is composed of a two- candle formation in a downtrending market. The body of the first candle is the same color as the current trend. The first body of the pattern is a long body; the second body is smaller. The open and the close occur inside the open and the close of the previous day. Its presence indicates that the trend is over.

The Japanese definition for Harami is pregnant woman or body within. The first candle is black, a continuation of the existing trend. The second candle, the little belly sticking out, is usually white, but that is not always the case (see Homing Pigeon). The location and size of the second candle will influence the magnitude of the reversal.

Criteria

• The body of the first candle is black; the body of the second candle is white.
• The downtrend has been evident for a good period. A long black candle occurs at the end of the trend.
• The second day opens higher than the close of the previous day and closes lower than the open of the prior day.
• Unlike the Western Inside Day, just the body needs to remain in the previous day's body, where as the Inside Day requires both the body and the shadows to remain inside the previous day's body.
• For a reversal signal, further confirmation is required to indicate that the trend is now moving up.

Signal Enhancements

• The longer the black candle and the white candle, the more forceful the reversal.
• The higher the white candle closes up on the black candle, the more convincing that a reversal has occurred despite the size of the white candle.

Pattern Psychology

After a strong downtrend has been in effect and after a selling day, the bulls open the price a higher than the previous close. The shorts get concerned and start covering. The price finishes higher for the day. This is enough support to have the short sellers take notice that the trend has been violated. A strong day after that would convince everybody that the trend was reversing. Usually the volume is above the recent norm due to the unwinding of short positions. (See Figure 2.34.)

BEARISH HARAMI Description

The Bearish Harami (shown in Figure 2.35) is the exact opposite of the Bullish Harami. Again, the pattern is composed of a two-candle formation. The body of the first candle is the same color as the current trend. The first body of the pattern is a long body; the second body is smaller. The open and the close occur inside the open and the close of the previous day. Its presence indicates that the trend is over.

Criteria

• The body of the first candle is white; the body of the second candle is black.
• The uptrend has been apparent. A long white candle occurs at the end of the trend.
• The second day opens lower than the close of the previous day and closes higher than the open of the prior day.
• For a reversal signal, confirmation is needed. The next day should show weakness.

Signal Enhancements

• The longer the white candle and the black candle, the more forceful the reversal.
• The lower the black candle closes down on the white candle, the more convincing that a reversal has occurred, despite the size of the black candle.

Pattern Psychology

After a strong uptrend has been in effect and after a long white candle day, the bears open the price lower than the previous close. The longs get concerned and start profit taking. The price finishes lower for the day. The bulls are now concerned as the price closes lower. It is becoming evident that the trend has been violated. A weak day after that would convince everybody that the trend was reversing. Volume increases due to the profit taking and the addition of short sales. (See Figure 2.36.)