What Is the Doji Candlestick Pattern?
The doji is a single candlestick pattern which can occur on a price chart. It indicates indecision in the market and can be exploited by traders to spot potential trading opportunities. In this article, we will look at the doji pattern in detail, highlight the different types of doji candles, explain how to trade them and much more!
Table of Contents
What Is a Doji Candlestick?
A doji is a type of candle which can appear on an asset’s price chart during a session where the opening and closing price are the same, or very close to one another. This results in a candle with a small, or no, body.
Each trading session is like a battle between buyers and sellers. A green bodied bullish candle tells us that the buyers have won a session, whereas a red bodied bearish candle tells us sellers have won.
A doji candle tells us the session was a stalemate, a draw. The market is indecisive. Neither buyers nor sellers won and, consequently, the price has ended up exactly where it started.
Types of Doji Candles
There are different types of doji, which can be identified by looking at the wick of the doji candle (i.e. the high and low prices for the session). The image below shows the three different types of doji candles and, in the following sections, we will discuss them in more detail.
Dragonfly Doji
A dragonfly doji is characterised by a T shape, where the opening and closing prices are close to the session high and the candle has a long lower wick. It shows that, despite there being strong selling pressure during the session, buyers have managed to push the price back up towards the level at which it opened.
Gravestone Doji
The gravestone doji, as pictured above, is the inverse of the dragonfly doji, occuring when the opening and closing prices are close to the session low and the candle has a long upper wick.
Just as the pattern is the inverse of the dragonfly doji, its symbolism is the opposite. Despite there initially being strong buying pressure, sellers have wrestled control of the session, forcing the price back up to where it opened.
Long-Legged Doji
The long-legged doji has long upper and lower wicks, with the price opening and closing at the same level. This doji candle demonstrates indecision in the market. Despite strong buying and selling pressure during the session, neither side made any progress.
How to Interpret the Doji Candle
Doji candles can appear in any market and on any timeframe, but what do they tell us about an asset’s price and where it’s heading next?
Uptrends vs Downtrends
The different types of doji candles are interpreted as signals of a potential price reversal depending on where they appear.
- Dragonfly: If it occurs at the bottom of a downtrend, it suggests that sellers may have run out of steam and is, consequently, considered to be a signal of a potential bullish reversal.
- Gravestone: If it appears at the top of an uptrend, the gravestone doji signifies that buyers may have lost momentum, and that a downward reversal is potentially imminent.
- Long-Legged: If it appears at the end of a trend, this could imply that a reversal is imminent. However, it could also mark the start of a consolidation period.
Trend Reversal Signal
A doji candle occurs when buyers and sellers struggle to seize control of a session. Although some view this as a sign of a potential price reversal, the indecisiveness which causes the candle's appearance means that many traders view doji candles as a neutral pattern.
They can be followed by a trend reversal; however, they can also be followed by a continuation of the current trend or mark the beginning of a period of consolidation. For many, a doji on its own does not provide enough information to make an accurate prediction about the price’s next movement.
For example, in the hourly USDJPY chart below, we can observe a clear downward trend.
During the downtrend, a dragonfly doji is formed. Although this is often viewed as a signal for a potential bullish reversal, after the doji’s appearance, the price continues its downward trajectory.
Accordingly, before entering the market, traders might want to try and look for further evidence of a trend reversal, or to wait and see what happens during the following sessions before taking a position.
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How to Trade Doji Candlestick Patterns
Traders can look for further evidence of a reversal by either identifying other chart patterns which accompany the doji candles, or by using technical indicators such as the Relative Strength Index (RSI) or the Stochastic Oscillator.
In the daily chart of USDJPY above, we can see that, during a downwards trend, a dragonfly doji is formed. This is meant to be a signal of a bullish reversal, but how can we look for further evidence of this reversal?
The image below shows the same chart, this time with a Stochastic Oscillator added below. A few trading sessions have passed since the dragonfly doji appeared.
Following the doji pattern, price has continued to move downwards. However, take a look at the Stochastic Oscillator.
Whilst USDJPY continues to record lower lows, the Stochastic Oscillator has started moving upwards. This is what is known as divergence and is a signal that prices may be about to change direction. The appearance of a dragonfly doji coinciding with this divergence may be enough to convince traders that an uptrend is on the verge of materialising.
Sure enough, price starts moving upwards and a new uptrend is formed. In this way, traders would have been alerted to a possible reversal by the dragonfly doji and, after finding additional evidence of a reversal from a technical indicator, could have entered a long position to capture the start of a new upwards trend.
Of course, just because a technical indicator has provided further evidence of a reversal, that doesn’t necessarily mean it is going to happen. Traders should always exercise good risk management when entering the market by setting a stop loss and continuing to monitor market conditions.
Conclusion
Doji candlestick patterns form when an asset’s price opens and closes the trading session at the same level. It signals a certain degree of market indecision, where neither buyers nor sellers are able to take control of the session in question.
They are generally interpreted as a sign of an imminent price reversal. However, rather than acting on a doji candle alone, traders will often seek further evidence of a trend reversal before entering the market.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
