What is the Doji Candlestick pattern?

16 Mar 2022  Read 1564 Views

A typical approach to forecasting trends and building a trading strategy is to examine candlestick patterns in the prices of stocks traded. When studied in conjunction with a variety of other data, there are a lot of different candlestick patterns that signal multiple possible market directions.

Today, we will understand one such candlestick pattern: the Doji candlestick pattern. 

The Doji pattern is one such candlestick formation. A Doji is a pattern in which the opening and closing prices of the stock is nearly equal during a trading session. They're frequently misinterpreted as parts of broader patterns, yet they don't happen very often in typical settings.

Let’s understand it more clearly.  

What is the Doji candlestick pattern?

The Doji candlestick pattern can result in significant trading rewards. Due to the rarity of occasions where the open and close prices are nearly identical, the word 'doji' denotes 'blunder' or 'mistake' in Japanese. The creation of a Doji pattern may signal an uncertain market, with neither buyers nor sellers gaining the upper hand.

 

Doji candlesticks come in various shapes and sizes, but most of them resemble a cross or a plus sign, with almost nonexistent bodies and greater shadows. Depending on market conditions, several types of Doji patterns may appear during consolidation periods, before price reversals, or during continuation trends.

The Doji candlestick is one of the tools used widely for Technical Analysis. Learn the Basics of Technical Analysis on Quest by Finology.

What does a Doji candle tell traders?

Technical analysts believe that the price reflects all available information about the stock, implying that the price is efficient. Still, historical price performance has no bearing on future price performance, and a stock's current price may have nothing to do with its true or intrinsic value. As a result, technical analysts use tools to sort through the clutter and find the best bets.

Four sorts of data are used to determine the shape of a candlestick pattern. Based on this structure, analysts can make inferences regarding price behaviour. There is an open, a high, a low, and a close on every candlestick. It makes no difference what period or tick interval is utilised. The body is the filled or hollow bar generated by the candlestick pattern. Shadows are the lines that extend beyond the body. When a stock closes higher than its open, it forms a hollow candlestick. The body of the candlestick will be filled if the stock closes lower. One of the most important candlestick formations is the Doji.

Meaning of the Doji

When a stock's open and close are nearly identical, it makes a Doji. From the standpoint of auction theory, Doji shows indecision on the part of both buyers and sellers. The price does not change because everyone is evenly matched, and the buyers and sellers are at odds.

Some observers have interpreted this as a sign of reversal. It could, however, be a period when buyers or sellers are gaining momentum for a longer-term trend. Doji patterns are typical during periods of consolidation and can assist analysts in spotting possible price breakouts.

Types of Doji candlestick patterns

The information gained from recognising this pattern is dependent on the environment in which it occurs and may alter depending on the different types of Doji candles encountered. Doji candlesticks come in five different varieties, each of which indicates a different trend or market climate:

Top 5 Types of Doji Candlesticks

  • Standard Doji: When seen on their own, standard Doji candlesticks may not communicate relevant data about market developments. However, when considered in the context of current patterns, it may signify a shift in the market's direction. A bullish candlestick before the Doji formation may signal an uptrend, whilst a bearish one below the pattern's low (with a lower high than the Doji) may signal a sell signal. In a buy scenario, these sorts of Doji may be followed by a bullish candlestick, which may later be followed by a downtrend.

  • Long Legged Doji: The wicks on either side of the chart's body are longer in these sorts of Doji candlesticks, indicating that the price fluctuated substantially throughout the session, with fierce competition between buyers and sellers. However, neither of these groups was able to control the market, resulting in the construction of a long-legged Doji. When evaluating these sorts of Doji candles, the location of the closing price in relation to the middle of the wick is paid particular attention to. If the close is above the midpoint, it may resemble a bullish pin bar, and if it occurs near the asset's support levels, it could imply an uptrend. If a bearish pin bar appears at the resistance levels, this could indicate a bearish trend.

  • Gravestone Doji: Long upper shadows with insignificant lower wicks characterise these Doji candles, which may signal that while buyers were successful in rising prices initially, they were unable to maintain this trend at the close. It may indicate a bearish reversal trend if it occurs during an uptrend, particularly at resistance or the Fibonacci retracement level. On the other hand, it could signal a bullish reversal if it happens at the support level during a downturn.

  • Dragonfly Doji: Dragonfly Doji, on the other hand, is the polar opposite of gravestone doji, with long lower wicks and small top shadows. They can emerge at the peak or bottom of uptrends or downtrends, and they might signal a shift in market direction. The price did not increase throughout the session above the open, as indicated by the tiny upper shadow. They generally serve as a bullish indicator when they appear at the bottom of a bearish trend.     

  • 4 Price Doji: This sort of Doji is distinguished by a single straight line with no upper or lower extensions, indicating that prices did not move in either direction during the session. The pattern's name comes from the fact that the high, low, open, and close are all at the same level, indicating a high degree of hesitation or a quiet market.  

How to use the Doji candlestick pattern?

Example 1:

The Dragonfly Doji appears near trendline support in the chart below. Although the Doji does not emerge at the top of the uptrend in this case, traders can still trade based on the information provided by the candlestick.

The Dragonfly Doji indicates that lower prices have been rejected, and the market has since surged upwards, closing near the opening price. The fact that the candle is near trendline support and that prices have previously bounced off this major trendline adds to this potential bullish bias.

 

Example 2:

 

In uptrends, it's a bad indicator for bulls, especially in higher time frames like 4 hours or daily candles, but the concept holds across all periods. It means the bulls are losing ground, and the bears are taking control of the price and pushing it lower. When a Gravestone Doji appears at the top of an uptrend, it means the upswing has come to an end, and the uptrend is most likely ended. It's a good idea to exit the transaction before the price decreases and the bears completely take over the market. If bulls try harder in the next candle, there's a chance to get out on highs, but that's not always the case, and it's preferable to get out of a long position sooner rather than later. The Gravestone Doji is a candlestick that indicates that the market has reached its highest point.

Limitations of Doji candlestick pattern

  • A Doji candlestick is a neutral indicator that provides little information when used alone. 

  • Additionally, because a Doji is not a common occurrence, it is not a reliable indicator of price reversals. There is no certainty that the price will continue in the expected direction after the confirmation candle.

  • The entry point for a trade might be a long way from the stop loss when the Doji's tail or wick is combined with the size of the confirmation candle. This means traders will have to either move their stop loss or cancel the trade because a stop loss that is too huge may not justify the deal's potential profit.

  • Estimating the potential value of a Doji-informed trade might be difficult because candlestick patterns rarely indicate price targets. Other instruments are required to exit a trade when and if it is profitable, such as candlestick patterns, indicators, or techniques.

Conclusion

When detected at the back end of uptrends or downtrends, many varieties of Doji can be excellent indications of a trend reversal. They may not be as strong a signal when they appear at the start of a trend. They may just indicate indecision in such instances. It's also worth noting that if the previous trend continues after a doji, it might behave as a phoney reversal pattern, encouraging you to keep a trade open. When trading with Doji patterns, it's also vital to examine the current market circumstances and other elements for analysis.

About the Author: Govind Singh | 5 Post(s)

Govind is an enthusiastic Management student, pursuing BBA from Christ University. He's a keen learner with strong academics and a passion for co-curricular activities. He wishes to up-skill himself in the broad domain of finance and business management.

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