Dark cloud cover and piercing pattern are gap patterns, that means that they need a gap between two
candles.
What is a gap?
A gap is an empty space
you can see between two candlesticks.
It appears on the chart because the price movements during that time have not been registered by the
platform.
It usually appears during the weekends because the Forex market is closed,
but of course the currency rates are still moving.
With this brief introduction about the gaps we can start having a look at these two patterns.
Let's start with that dark cloud cover.
So the dark cloud cover is a bearish reversal pattern
and it is composed of two candlesticks.
The market must be in an uptrend.
Once again this condition is very very important.
The first candle must be green and the second candle must be red, then the market gaps higher on the
open of the second candle.
So there is a gap between the first and the second candle. Last condition is that the real body of the
second candle must close into the body of the first candle.
Many traders also include that the second candle must close in the first half of the real body of the
first candle.
Ok, it looks a bit complicated but it's not really that hard. If you can follow me just another minute,
I introduce the piercing part and then I will show the logic of both patterns and my considerations
about them. The bullish equivalent of the dark cloud cover pattern is the piercing pattern.
So for this pattern, the market must be in a downtrend and the first candle must be red, in line with
the downtrend.
The second candle must be green and this time the gap is a gap low,
that means that the second candle starts at an opening price that is lower than the closing price of
the first candle.
Once again, last condition is that the second candle closes into the body of the first candle.
And we may add that it needs to close above the first half of the real body of the first candle.
We have always analyzed the patterns from a logical perspective trying to understand the reason of the
formation and where supply and demand may be addressed.
I will give you the logical explanation for these two patterns,
but this time I will also make an exception and will also provide you with an historical background because
I believe that it is necessary to fully understand these two signals.
Let's start with what this pattern is saying to us.
The market is in a downtrend and the first candle of the piercing pattern is confirming the downtrend.
When the market opens again there is a gap low. This gap low can be considered as a question mark.
It means: "how will traders react to this unexpected new price?".
The second candle of the pattern represents the answer.
If the candle is able to fill the gap and also close into the real body of the first candle that means
that buyers found convenient
the unexpected new price after the gap low. So they opened long positions at the new price, increasing
the demand and pushing the currency pair higher.
We can say the same for the dark cloud cover. The first candle is confirming the uptrend.
The gap then represents the question: "how will traders react to this unexpected new price?".
The second candle represents the answer.
If the price goes down and the candle fills the gap and closes into the real body of the first candle, then
sellers had a reaction to this new price, they sold the pair increasing the supply.
They look very logical and actually they are and they are also very good signals
from my experience, but unfortunately we will not use them a lot and we need to have a look at the historical
background of candlesticks to understand why dark cloud cover and piercing pattern will not be very
useful for our trading.
Candlesticks are used to monitor and study the prices in any financial markets.
They were created in Japan to track the price of the rice.
So of course they were not created initially for the forex market.
Most of the patterns that you are learning in this course go beyond the forex market.
They can also be applied to study other financial markets like the stock market for example. Dark cloud
cover and piercing pattern are two examples of patterns that are very useful in other financial markets
but not Forex.
This is simply because of a characteristic of the forex market. Forex market is open 24 hours per day.
It doesn't close and then reopens the next day.
So it is very hard to find gaps and, for this reason, it is very hard to find these two patterns.
Here we have Apple on a daily chart quoted on the Nasdaq,
that is an American Stock Exchange.
Why does this chart have so many gaps?
Because Nasdaq is open from 9:30 in the morning to 4:00 p.m. When the market reopens at 9:30
of the following day, price might be different from the previous close.
If you have a closer look at the chart, you can see a piercing pattern right here and the signal also
did a good job.
Going back to the Forex market, I want to express my final words about this two patterns.
In my experience,
it is very rare to find a dark cloud cover or a piercing pattern in a Forex chart, but when they
appear, they are usually powerful reversal signals.
So you can definitely use them to analyze the market.