Ominous Clouds. Will the Trend Change?

This article considers the graphical analysis pair patterns named the "Dark Cloud Cover" and the "Piercing Line".

The Dark Cloud Cover and Piercing Line are attributed to reversal patterns.

Gregory L. Morris describes the Dark Cloud Cover pattern in the following way:

"Since it appears in an uptrend, the first day turns out to be a long white candlestick supporting this trend. The second day opens above the white day maximum. The price fall throughout the day leads to closing below the midpoint of the long white day."

The Dark Cloud Cover and the Piercing Line patterns:

The Dark Cloud Cover consists of two candlesticks. The first pattern candlestick is formed in an uptrend. This is a light candlestick with a long body. The second one is dark. It opens above the maximum of the first candlestick and closes near its minimum.

The Covers signify a decline in the market which opens opportunities to place open-to-sale positions.

The Piercing Lines are different: after they appear, the trend tends to be upward, and this suggests placing buy-to-open positions.

Event detection method

For the Dark Cloud Cover pattern, we will spot the pattern on charts in the following way:

• Find an ascending trend by determining a consistently rising window of several candlesticks;

High[3] > High[4]

High[2] > High[3]

• Find a combination of two candlesticks, the first one of which is white, and the second is dark. It must open above the maximum of the first candlestick and close near its minimum.

Close[2] > Open[2] (The second candlestick is bullish)

Close[1] < Open[1] (First candlestick is bearish)

Open[1] > Close[2] (The first candlestick opened with a gap up)

(Close[2] - Close[1]) * 100 / (Close[2] - Open[2]) > PP%

(Candlestick 1 must overlap the Candle 2 body by more than PP% - quality criterion)

• The pattern is formed – place a buy-to-open position.

The way the Dark Cloud Cover is formed is outlined above. The Piercing Line is a mirrored version of this pattern.

We test the signals generated with Covers and Piercing Lines on a large volume of historical data refering to the various financial instruments and on two timeframes.

In addition, we test the patterns in three combinations optimising the conditional parameter: the percentage of candlestick overlap. Let us call it PP.

The PP overlap value is calculated with the following formula:

PP = ( Max(Close[1], Close[2]) - Min(Close[1], Close[2]) ) * 100 / S,

where S = Max(Open[2], Close[2]) - Min(Open[2], Close[2] )

The Dark Cloud Cover with the above parameter looks the following way (Fig.2):

The figures illustrate Cloud covers, and the Piercing Line is a mirrored image of the pattern.

What is the model conditional parameter?

• The percentage of candlestick overlap is the size of candlesticks relative to each other. The higher is the percentage of candlestick overlap, the stronger the black candlestick covers the white in the Dark Cloud Cover pattern (Piercing Line is different, the white candlestick overlaps the black one), and the more noticeable the patterns are.

Now, let's discuss the conditions for opening and closing a trading position.

Opening a position:

After the signal is formed, a position is opened at the opening of a new candlestick:

• The Dark Cloud Cover pattern is a sell signal.
• The Piercing Line pattern is a buy signal.

Closing a position:

In all conditions, the position lifetime is set to 5 or 10 (in candlesticks).

Having defined all the conditions and set the necessary parameters, let's go down to testing!

Analysis of the results

Firstly, we estimate the results by the sample size:

For the 1-hour timeframe (H1):



For a daily timeframe (D1):

Total: 2,101,235 candlesticks and 112,228 events (Covers and Piercing Line patterns).

Next what we analyse is the share of Covers and Piercing Lines (in %) in the total number of initial candlesticks by aggregating data from the two timeframes:

The results on grouping show that the distributions of Covers and Piercing Lines are roughly the same despite the type of the financial instrument.

• Covers and Piercing Lines with the 30 PP parameter range from 1.12 up to 1.58 % of the total candlestick number;
• Covers and Piercing Lines with 50 PP parameter range from 0.68 up to 1.00 % of the total candlestick number;
• Covers and Piercing Lines with 70 PP parameter range from 0.33 up to 0.48 % of the total candlestick number.

Note that the more noticeable the Covers and Piercing Lines are, the smaller is their share in the total number of candlesticks.

Next, we consider the results of handled trading signals received from the patterns.

We evaluate the results according to two criteria:

• Momentum (m) – reflects the average increment rate of financial quotes when fixing positions, in %. The positive momentum value indicates the profitability of the handled signal, a negative value indicates a loss.
• SPP – the share of profitable positions, %.

Momentum in % and the share of profitable positions in % in terms of holding positions, timeframes and Covers/Piercing Lines parameters:

Momentum in % and the share of profitable positions in % by financial instrument types.

9 out of 11 average momentum values are negative.

We also can outline some peculiarities.

To do this, we can visualize the results in the form of momentum distribution (m) over each parameter (a holding period, timeframe, Covers and Piercing Lines (PP) parameters, type of financial instruments):

The chart above illustrates the distribution of momentum depending on the parameters. The chart consists of two parts: a "box" and "tails" or "whiskers". 50% of the observed values are placed within the box, the remaining 50 are represented with tails. The end of the lower tail shows the smallest of the observed values, the end of the upper tail is the largest one. The cross shows the average value.

The analysis of the results allows us to make the following preliminary conclusions:

• closing positions on the 10th candlestick minimizes the losses compared to the 5th candlestick.
• the average momentum value on the hourly timeframe is higher than on the daily one, so it minimizes signal loss on hourly charts.
• the signal is less profitable when the percentage of candlestick overlap is more than 30;
• the best momentum is noted for Indices in comparison with other financial instruments.

Let’s review the results in terms of holding positions, timeframes, model parameters (the percentage of candlestick overlap) and types of financial instruments.

Take the notation keys:

«H1 / 5» – closing the position on the 5th candlestick when working on the 1- hour timeframe;

«H1 / 10» – closing a position on the 10th candlestick when working on the 1-hour timeframe;

«D1 / 5» – closing a position on the 5th candlestick when working on the daily timeframe;

«D1 / 10» – closing a position on the 10th candlestick when working on the daily timeframe;

SPP - the share of profitable positions, %,

PP - the percentage of candlestick overlap, %;

The number of Covers and Piercing Lines, Momentum in %, The share of profitable positions in %, in terms of holding positions, timeframes and types of financial instruments including the percentage of candlesticks overlap equal to more than 30

The number of Covers and Piercing Lines, Momentum in %, The share of profitable positions in %, in terms of holding positions, timeframes and types of financial instruments including the percentage of candlesticks overlap equal to more than 50

The number of Covers and Piercing Lines, Momentum in %, The share of profitable positions in %, in terms of holding positions, timeframes and types of financial instruments including the percentage of candlesticks overlap equal to more than 70

Summing up all the results using diagrams:

So, we can draw the following conclusions.

The highest momentum of 0.021 % belongs to the signals generated by the Dark Cloud Cover and Piercing Line patterns on the daily timeframe, with the following model parameter: the percentage of candlestick overlap is more than 50.

However, the momentum obtained from the considered patterns is very small, i.e. we can attribute them to profit-neutral patterns.

Detailed results are presented in the appendix:

XLSX (0.49 MB)Applicationa to the article 'Clouds are coming. Will the trend change' eng.xlsx