The Doji Candlestick Patterns
What is the Doji Pattern?
The Doji is one of the more significant single candlestick patterns. On its own, the Doji is a neutral candlestick that indicates indecision in the market. When the Doji appears in an extended trend, it forewarns of a potential transition to a trend reversal that can be either a bullish or a bearish trend reversal, depending on where the Doji appears on the price chart and the nature of the trend that it appears in.
The Doji Formations
The Doji is usually a relatively short candlestick with no real body, or very little real body. It indicates that the opening and closing prices for the period were at the exact same level or very close together. This is where the pattern gets its name as Doji means "same" or "concurrent" in Japanese. The Doji can, however, have longer upper or lower wicks or shadows. The Doji formation has different names depending on the location of its real body, and the lengths of the upper and lower shadows.
The Rickshaw Man or Long-Legged Doji
A Doji with long upper and lower shadows is called a Rickshaw Man or a Long-Legged Doji. The long shadows indicate that the market rallied and sold off significantly during the session but that neither position was held as the market closed where it had opened. This is an indication of great uncertainty and lack of direction.
The Dragonfly Doji
A Doji with a long lower shadow and no upper shadow is called a Dragonfly Doji. It has greater significance in a downtrend as its long lower shadow has bullish implications and indicates that the sellers were initially able to drive the price lower during the session, but then there was a shift in power and the buyers were able to push the price back up to its open by the time the session closed. Thus, it shows a shift in power from the bears to the bulls and is usually an early indication that a downtrend is running out of steam and may soon come to an end.
The Gravestone Doji
A Doji with a long upper shadow and no lower shadow is called a Gravestone Doji. It is similar in shape as the Shooting Star, except that it has no real body. The Gravestone Doji is the opposite of the Dragonfly Doji and has greater significance in an uptrend as its long upper shadow has serious bearish implications. It indicates that the buyers were in control of the market early on and were able to push the price up, but were unable to hold the market at the higher levels, conceding control to the sellers who were able to drive the price back down to its open by the end of the session. It shows a shift in power from the bulls to the bears and usually indicates that the uptrend is running out of steam and could end soon.
What the Doji Pattern tells us
A Doji that appears in a trend after a long candlestick, such as a Marubozu, is quite significant. In terms of market psychology, the Doji indicates that there is now indecision and uncertainty in the market with neither buyers nor sellers able, or willing, to move the price to significant levels, in contrast to the strength shown in the previous candlesticks. This would indicate a shift in sentiment and a weakening of the current trend which could lead to a possible reversal. At this point the Doji becomes resistance in an uptrend or support in a downtrend. It is important to note that the Doji does not mark the start of a trend reversal but marks the start of a possible shift in momentum, which may take a session or two to complete before the reversal occurs.
A Gravestone Doji, with its tall upper shadow is quite significant when it appears at a resistance area, or when the market is overbought in an uptrend. Here it indicates that there is either heavy profit taking at higher prices or a lack of new buyers. This could be a bearish development. On the other hand, a Dragonfly Doji that appears at a support area, or when the market is oversold in a downtrend, could be an indication of bears taking profit at lower prices or a lack of fresh selling. This would be a bullish development.
To have any significance, a Doji must appear in an existing trend and is more significant if it appears at or near a trend line or a support and resistance line, or when the market is oversold or overbought. However, the Doji becomes less significant if there are already a series of Doji in the current trend, and a Doji is less significant when the open and close is not the same level.
Trading the Doji
The appearance of Doji is not an outright signal to buy or sell, instead it forewarns of a possible trend reversal when it appears in a trend. Therefore, a trader should take note of the Doji and wait for confirmation of the reversal before taking up a position.
The bullish Doji pattern does not provide a profit target but a trader could implement a profit target based on a measured moved defined by an acceptable risk/reward ratio or some other trading mechanism can be used to exit the trade. This could be a Fibonacci retracement level, the appearance of a bearish candlestick formation, or a simple trailing stop.
As with most trend reversal patterns, the Doji pattern becomes more reliable depending on where it appears on the price chart in relation to trend lines, pivot points, and support and resistance lines, etc. A Doji pattern at or near a trendline can be used in anticipation that the test of the trendline is likely to fail.
Trading the Bullish Doji
Should the Doji appear in an established downtrend, the trader would anticipate a bullish trend reversal but should wait for confirmation of the reversal to the upside. This confirmation could be in the form of the price breaking through the upper support trend line, or a Moving Average crossover, or the formation of another bullish candlestick reversal pattern, etc. At this point the trader would look to go long or place a buy order.
A logical place for a stop loss would be the low of the Doji as a price move below this level would suggest that the indecision in the market has been resolved in favor of the bears and would nullify the reversal signal. If the protective stop-loss is too far from the entry to provide a favorable risk/reward ratio, the trader could wait for a possible pull-back towards the potential support area represented by the Doji. This would place the entry much closer to the protective stop and would reduce the capital at risk on the trade, though there is no guarantee that a pull-back will occur. Remember that confirmation of the pattern must first be obtained before placing a buy order.
Trading the Bearish Doji
When the Doji appears in an existing uptrend, the trader would anticipate a trend reversal and would wait for confirmation of the reversal to the downside. This confirmation could again be in the form of the price breaking through the lower support trend line, or a Moving Average crossover, or the appearance of a bearish candlestick reversal pattern, etc. At this point the trader would look to short or sell the market.
A logical place for a stop loss would be the high of the Doji as a price move above this level would suggest that the indecision in the market has been resolved favor of the bulls and that the current uptrend is more likely to continue. If the protective stop-loss is too far from the entry to provide a favorable risk/reward ratio, the trader could wait for a possible pull-back towards the potential resistance area represented by the Doji. This would place the entry much closer to the protective stop and would reduce the capital at risk on the trade, though there is no guarantee that a pull-back will occur. Confirmation of the pattern must first be obtained before placing a sell order.
The Doji in Other Candlestick Patterns
One or more Doji can also form part of other candlestick patterns, such as in a Morning Star, which would then be called a Morning Doji Star or an Evening Star, which would then be called an Evening Doji Star, or a Harami pattern, in which case it is called a Harami Cross. Then there is the Tri-Star pattern that consists of three Doji, with the middle one being a Doji Star.