Select Page

Piercing Pattern and Dark Cloud Cover

Piercing Pattern

A piercing pattern consists of two candlesticks and is a bullish reversal indicator. It occurs towards the end of a downtrend. The first candle body should be red; the second candle body should be green. The first candle body should open near its high and close near its low with an average or above-spread. It is expected that the second candle will gap down below the close of the first candle body, and increased buying pressure will cause the second candle to close well within the body of the first candle. The piercing pattern is similar to the bullish engulfing pattern; however, the piercing pattern does not immerse the preceding candle entirely, it only pierces it significantly. The piercing pattern is not as significant of a reversal indicator compared to the bullish engulfing pattern, although it is still a reliable warning signal. One crucial aspect of the piercing pattern is that the second candlestick must close 50% or greater into the preceding candle. Remember, if a downtrend is going to reverse, not just trade sideways or retrace, demand must continuously exceed supply. If the 50% penetration criterion is not met, we cannot consider the formation to be a reflection of strong demand at the price area.

Figure 1.01 Piercing Pattern

Chart, waterfall chart

Description automatically generated Figure 1.01 illustrates that both candlesticks in the piercing pattern should be of a relatively wide-spread, average at the least, for the pattern to reflect increased demand, strong enough to change the downtrend. Both candlesticks should be relatively widespread.

Figure 1.02 Example of a Piercing Pattern

Chart

Description automatically generated (NASDAQ: HAS)

In Figure 1.02, the price movement of $HAS is descending quickly until a piercing pattern forms. Prices gap down to open beneath the $80 price area, reflecting aggressive selling; however, demand increases at this area to close prices greater than 50% into the preceding red candle.

The piercing pattern here indicates that there is strong demand at this price area; it is unlikely prices will trade lower than this level unless sellers are more aggressive at this price. In Figure 1.16, let’s say we are short. As prices descend, the piercing pattern forms. Now we grow cautious. We distinguish the exact price area at which the piercing pattern formed. If prices fail to close below the piercing pattern, buying intensity continues to exceed selling intensity at the price area; the downtrend will not continue. We might look to exit our position if sellers cannot move prices lower than the piercing pattern. A similar approach can be applied to the bullish and bearish engulfing pattern as well. Of course, we will always adhere to predetermined stop-loss and profit-taking criteria. Arbitrary trading decisions are unlikely to result in consistent profitability.

This formation occurs on the weekly chart and establishes greater significance than if it forms on the daily chart. Formations and patterns that materialize on a longer period chart will produce signals of greater magnitude. Therefore, a formation or signal on the monthly chart will have more significance than signals on the weekly or daily chart, and the weekly chart will generate more pronounced signals than the daily chart. Conducting your analysis with a macro to micro approach is conducive to profitability. Identify the overall long-term trend, then work progressively towards shorter-term trends and charts. 

Figure 1.03 Valid Piercing Pattern

Chart

Description automatically generated (NYSE: TR)

Figure 1.03 shows a vigorous downtrend until a piercing pattern forms. Prices perform a bullish reversal after the piercing pattern. Prices increase expeditiously, stall, and perform a bearish retracement. An additional piercing pattern forms at the bottom of the bearish retracement and prices continue to uptrend thereafter. The initial piercing pattern preceded a short-term bullish reversal, which ultimately evolved into an intermediate-term uptrend. The second piercing pattern formed at the bottom of the bearish retracement of the bullish reversal (uptrend). The uptrend continued after the piercing pattern at the bottom of the bearish retracement.

You will frequently see the candlestick patterns discussed form at the end of a retracement, such as the piercing pattern in November. Be sure to keep this in mind, reversal patterns formed during the retracement of a strong trend are more actionable signals.

We will objectify the piercing pattern and backtest it after discussing the Dark Cloud Cover formation.

Dark Cloud Cover

Dark cloud cover is the opposite of the piercing pattern and occurs at the end of an uptrend. It is considered a bearish reversal pattern in which a red candle opens above the close of the preceding green candle, fails to maintain bullishness, and ends the day closing at least 50% into the body of the previous green candle. When this occurs, it is of the general notion that selling aggression has increased at the corresponding price level. Therefore, it is unlikely prices will close higher than the dark cloud cover unless demand increases and exceeds supply at the price area. The dark cloud cover intimately resembles the bearish engulfing pattern, although the initial green candlestick is not fully engulfed.

Figure 1.04 Dark Cloud Cover 

Chart

Description automatically generated A dark cloud cover is simply the inverse of a piercing pattern, as shown in Figure 1.18. The 50% penetration criteria ensure the selling intensity which generated the pattern was strong. Both candlesticks should be relatively widespread.

Figure 1.05 Example with Dark Cloud Cover

Chart

Description automatically generated (NASDAQ: FB)

In Figure 1.05, the price movement of $FB is trending upwards before reversing. At the top of the uptrend, a doji materializes signaling demand exhaustion at the price area. A valid dark cloud cover forms several sessions later on extraordinary volume, marking the end of the current trend and the beginning of a reversal. Supply continuously exceeds demand as an intermediate-term downtrend is instituted.

Interpretation of the dark cloud cover and the bearish engulfing pattern is similar. Prices gap up, indicating strong demand; however, demand exhausted while selling intensity ramped up to close prices considerably lower. The formations symbolize a shift in power; from strong buying to strong selling.

Quite a few candlestick formations and patterns transpire at the top of the uptrend. When this occurs, it may be difficult to filter out the noise and accurately forecast price movement. A comprehensive trading strategy will alleviate confusion and ambiguity. We shouldn’t succumb to analysis paralysis; we get a buy/sell signal, or we don’t.

I did not mark the additional candlestick patterns that formed; however, you can observe two bullish engulfing patterns and a bearish engulfing pattern. All-out war between buyers and sellers occurred at the top of the uptrend.

Price decreases are not the result of short-selling alone. When buyers holding long positions close their position, they have to sell shares. It does not matter if share buyers close their position for a gain or loss. If a shareholder sells their shares, they contribute to supply. Selling owned shares contributes to selling volume. This moves prices lower if buying intensity does not exceed selling intensity for the session. Traders may close their positions for a multitude of reasons: profit-taking, a belief that the underlying stock is overvalued or undervalued, to free up buying power, fear, subjective interpretation of technical indicators, market sentiment, sector performance, earnings, economic factors, the list goes on. 

The potency of these formations can be evaluated through volume analysis. The dark cloud cover formed on very high volume; exceptional selling intensity served as a catalyst. Above-average volume means more transactions occurred than average. If a dark cloud cover forms on high volume; a high amount of sell orders were filled at the price area.

Figure 1.06 Dark Cloud Cover with No Upper Shadow

Chart

Description automatically generated (NASDAQ: GOOG)

In Figure 1.06, the initial price movement of $GOOG is uptrending until a valid dark cloud cover forms. Prices quickly sell off thereafter and a robust descent takes place. The dark cloud cover in Figure 1.18 is exemplary, as the red candle possesses no upper shadow, which indicates strong selling pressure at the market open. Even though this happens, there is a small lower shadow under the closing price of the red candle, meaning that there is enough buying pressure to prevent the underlying stock from closing at the low of the day. We should still assess the dark cloud cover as a price level in which selling exceeds buying. Prices will not close above the dark cloud cover and continue the uptrend unless buyers trade aggressively.

Objectifying the Piercing Pattern and Dark Cloud Cover

Piercing Pattern Criteria

  1. Piercing candle’s close >= Mid-point between pierced candle’s open and close price

The piercing candle’s close is greater than or equal to the mid-point of the open and close price of the pierced candle. This ensures the piercing candle closes at least 50% into the pierced candles body.

  1. Piercing candle’s close < Pierced candle’s open

The piercing candle’s close price is less than the pierced candle’s open price. This ensures the candlestick formation is a piercing pattern and not a bullish engulfing pattern.

  1. Piercing candle’s open < Pierced candle’s close

The piercing candle’s open price is less than the pierced candle’s close price.

  1. Piercing candle’s (close price – open price) >= Pierced candle’s (open price – close price)

The difference between the close price and open price of the piercing candle is greater than or equal to the difference between the open price and close price of the pierced candle. This ensures the piercing candles body is larger than the pierced candle’s body.

  1. Piercing candle’s (close price – open price) >= Average True Range / 2

The difference between the piercing candle’s close price and open price is greater than or equal to the Average True Range Measurement divided by two. This increases the chance of a wide-body piercing candlestick.

Dark Cloud Cover Criteria

  1. Covering candle’s close <= Mid-point between covered candle’s open and close price

The covering candle’s close is less than or equal to the mid-point of the open and close price of the covered candle. This ensures the covering candle closes at least 50% into the covered candles body.

  1. Covering candle’s close > Covered candle’s open

The covering candle’s close price is less than the covered candle’s open price. This ensures the candlestick formation is a dark cloud cover and not a bearish engulfing pattern.

  1. Covering candle’s open > Covered candle’s close

The covering candle’s open price is greater than the covered candle’s close price.

  1. Covering candle’s (open price – close price) >= Covered candle’s (close price – open price)

The difference between the open price and close price of the covering candle is greater than or equal to the difference between the close price and open price of the covered candle. This ensures the covering candles body is larger than the covered candle’s body.

  1. Covering candle’s (open price – close price) >= Average True Range / 2

The difference between the covering candle’s open price and close price is greater than or equal to the Average True Range Measurement divided by two. This increases the chance of a wide-body covering candlestick.

Figure 1.07

Figure 1.08

Piercing Pattern and Dark Cloud Cover + ATR

Figure 1.08 shows our objectified criteria for the piercing pattern and dark cloud cover fulfilled on a candlestick chart.

Backtesting the Objectified Criteria

Entry Criteria (Long)

  1. %D >= 5 (%D is greater than or equal to 5)
  2. A piercing pattern forms

Exit Criteria (From Long Position)

  1. A 2.5% profit is achieved

Or

  1. %D line crosses under 20 (full stochastics parameters)

Or

  1. %D crosses under and closes below 5 (incase a position is opened when %D measures between 5 and 20)

Entry Criteria (Short)

  1. %D <= 95 (%D is less than or equal to 95)
  2. A dark cloud cover forms

Exit Criteria (From Short Position)

  1. A 2.5% profit is achieved

Or

  1. %D crosses over and closes above 80 (full stochastics parameters)

Or

  1. %D crosses over and closes above 95 (incase we open a position when %D is between 80 and 95)

Figure 1.09

Piercing Pattern / Dark Cloud Cover + Stochastic Oscillator

Figure 1.09 shows the exact set up required for a long/short position to be entered. The marked “take-profit” arrows indicate the session our position was closed on. A 2.5% profit was achieved for all positions in the figure.

Figure 1.10 Backtesting Sample

Piercing Pattern and Dark Cloud Cover Backtest

Figure 1.10 shows performance test data for our system. Only 24 positions were executed; we need to observe more trades executed before we consider the system viable. The backtest was performed to give you an idea of how candlestick patterns can be objectified and incorporated into your trading strategy.

Important Notes

We haven’t observed enough trades to justify a statistical inference of our strategy’s viability.

However, you can copy the code discussed in this article, make necessary modifications, and backtest the strategy to ascertain efficacy.

The strategy is likely incomplete and won’t perform well; the piercing pattern and dark cloud cover function better as exit signals rather than entry signals.

The Truth About Piercing Patterns and Dark Cloud Covers

The formations are potent signals only when objectified with strict criteria. You’re going to see piercing patterns and dark cloud covers form all over a chart without strict criteria and most will be inconsequential. I don’t advise subjectively interpreting each pattern. Doing so consumes time and it’s virtually impossible to know if you’re interpretation has a positive expected outcome without objectifying your interpretation and testing it.

Both patterns are great exit signals for swing-traders and day-traders. If you’re long and a dark cloud cover forms, you might exit your position. If you’re short and a piercing pattern forms, you might exit your position.

Source Code

//@version=4
strategy(“DCC AND PP”, shorttitle = “DCC AND PP”, overlay=true, process_orders_on_close = true, default_qty_value = 100000, default_qty_type = strategy.cash)

startDay = input(defval = 1, title = “Start Day”, type = input.integer, minval = 1, maxval = 31)
startMonth = input(defval = 1, title = “Start Month”, type = input.integer, minval = 1, maxval = 12)
startYear = input(defval = 2001, title = “Start Year”, type = input.integer, minval = 1800)
endDay = input(defval = 1, title = “End Day”, type = input.integer, minval = 1, maxval = 31)
endMonth = input(defval = 1, title = “End Month”, type = input.integer, minval = 1, maxval = 12)
endYear = input(defval = 2050, title = “End Year”, type = input.integer, minval = 1800)
begin = timestamp(startYear, startMonth, startDay, 00, 00)
end = timestamp(endYear, endMonth, endDay, 23, 59)
period() => time >= begin and time <= end ? true : false

takeProfitPercent = input(2.0, title=’Take Profit (%)’, type=input.float, step = 0.1) / 100

shortTakeProfit = strategy.position_avg_price * (1 – takeProfitPercent)
longTakeProfit = strategy.position_avg_price * (1 + takeProfitPercent)

longTrailPercent = input(title=”Trail Long Loss (%)”, type=input.float, minval=0.0, maxval = 100.0, step=0.1, defval=100) * 0.01

shortTrailPercent = input(title=”Trail Short Loss (%)”, type=input.float, minval=0.0, step=0.1, maxval = 100.0, defval=100) * 0.01

longStopPrice = 0.0, shortStopPrice = 0.0

longStopPrice := if (strategy.position_size > 0)
stopVal = close * (1 – longTrailPercent)
max(stopVal, longStopPrice[1])
else
0

shortStopPrice := if (strategy.position_size < 0)
stopVal = close * (1 + shortTrailPercent)
min(stopVal, shortStopPrice[1])
else
999999

if strategy.position_size > 0
strategy.exit(id=”Take Profit”, stop= longStopPrice, limit=longTakeProfit)
if strategy.position_size < 0
strategy.exit(id=”Take Profit”, stop= shortStopPrice, limit=shortTakeProfit)

maxIntrasessionLoss = input(100.0, title=”Max Intrasession Loss”, type = input.float)
strategy.risk.max_intraday_loss(maxIntrasessionLoss, strategy.percent_of_equity)

atr = atr(14)

volma = sma(volume, 28)

DarkCloudCover = close <= ((open[1]+close[1])/2) and close > open[1] and open > close[1] and (open – close) >= (close[1] – open[1]) and (open – close) >= ((atr)/2)
PiercingPattern = close >= ((open[1]+close[1])/2) and close < open[1] and open < close[1] and (close – open) >= (open[1] – close[1]) and (close – open) >= ((atr)/2)

periodK = input(14, title=”%K Length”, minval=1)
smoothK = input(3, title=”%K Smoothing”, minval=1)
periodD = input(3, title=”%D Smoothing”, minval=1)
k = sma(stoch(close, high, low, periodK), smoothK)
d = sma(k, periodD)

rsi = rsi(close, 14)
shortsignal = DarkCloudCover
exitshort = crossover(d,80)
longsignal = PiercingPattern
exitlong = crossunder (d,20)

if longsignal
strategy.entry(id=”Long”, long = true, when = period())
if shortsignal
strategy.entry(id = “Short”, long = false, when = period())
if exitshort
strategy.close(id = “Short”)
if exitlong
strategy.close(id = “Long”)

BEFORE YOU GO!

Try to objectify your trading!

Join our Discord server! We will help you build a mechanical trading system and backtest it! We will send you the code; you can backtest the system on ANY stock at ANY time!

The servers getting a bit large.

https://discord.gg/EyQqtkfjv5

Make sure to join before we are forced to close off access for a bit!

Courses Archive – Kioseff Trading

Check out our Youtube Channel for trading systems with code access! (You can backtest the systems at any time AND set alerts)

Kioseff Trading – YouTube

Follow our twitter!

Kioseff Trading (@KioseffTrading) / Twitter

-Kioseff Trading

Legal Disclaimer: The information contained in the article is not intended as, and shall not be understood or construed as, financial advice. The author is  not an attorney, accountant, or financial advisor, nor are they holding themselves out to be, and the information contained in this article is not a substitute for a professional who is aware of the circumstances and facts of your personal financial situation. 

The author does not have a position for the discussed securities and does not plan to open a position for the discussed securities. 

Losses can exceed investment. Any stock mentioned throughout the article does not constitute advice or a recommendation. Any losses incurred that are due to error, accident, malfunction, or any loss due to any reason is not the legal responsibility or fault of the author. 

The article reflects an expressed opinion from the author. 

© Kioseff Trading. All rights reserved. No portion of this article, or any content on the website, may be redistributed or passed as one’s own without express permission from the author