Understand Doji Candlestick Pattern and How To Trade With it
Consider a market situation when buying trends are strong, but some traders also anticipate the ongoing trend to reverse; hence they sell. What will happen in this case? If all traders go on a selling spree, the market will fall. But when it is not strong enough, the market can reflect indecision. Traders keep a lookout for such moments to predict when market trends might switch. But how would you know when it’s going to happen by looking at a chart? Well, technical traders look for Doji candlestick patterns to appear in the trading chart.
Doji candlesticks belong to the family of Japanese candlesticks charts. It has got its name from its unique formation, which denotes indecision. We will try to understand what a Doji candlestick is and what should be your stand when you see one.
What are the candlestick patterns?
Candlestick charts are a unique form of trading indicators invented in 17th century Japan by rice traders. They used these patterns to anticipate price movements to trade. Modern traders use a variety of candlestick patterns, among those Doji is one. In Japanese, Doji means mistake or blunder. It often appears during an uptrend or a downtrend, signifying equality between bullish and bearish trends.
How will you recognise a Doji candlestick when you see one? Well, it looks like a cross or star, hence the name, Doji Star.
The difference between Doji and other candlestick patterns is it has no real body. The opening and closing values are the same, with different high and low. A long-legged Doji, with long upper and lower shadows, is called a “Rickshaw Man”.
Since a Doji is often formed during an uptrend or downtrend, it is considered a possible indication of a trend reversal.
Types of Doji candlestick patterns
Doji candlestick can take many forms, each with unique features and interpretation. Let’s discuss them one by one.
Doji Star – It looks like a star with the same opening and closing values, and equal length upper and lower wicks. It appears when neither bullish nor bearish trend is significant enough to sway market sentiment.
Long-legged Doji – A Doji star with extended upper and lower wicks. It too represents indecisive sentiment with higher volatility.
Dragonfly Doji – You can find it at the bottom of a downtrend, which signifies rejection of lower prices. Unlike, Doji Star and Long-legged Doji, Dragonfly doesn’t depict market indecision. Instead, it signals a possible upward trend reversal. You can recognise a Dragonfly from its unique appearance, no real body, and long bottom wick.
Gravestone Doji – Gravestone Doji lies on the other side of the spectrum of Dragonfly Doji. It appears during an uptrend, showing market rejection for a higher price. It is a Doji candle without a real body and extended upper shadow.
4-price Doji – It is represented by a single horizontal line, which depicts ultimate indecision in the market. This pattern appears when open and close, and high and low are all the same.
How to deduce a Doji candle
What to do when a Doji appears in a candlestick chart? Whether you are a new trader or an experienced one, taking a stance during market indecision is difficult. But preparing yourself with knowledge is possibly the best protection you can choose to avoid making mistakes. Doji, in itself, is trend neutral, meaning it doesn’t indicate any trend reversal. But a Doji with other candles from the chart can confirm a change in trend.
Each candlestick has four parts, namely, an opening and closing, and high and low prices of the day. Looking at it will give you an idea about the price movement of an asset. The opening and closing prices together create a thick section, called the body. Higher the difference between the opening and closing prices, the longer will be the real body of the candle. On either side, the highest and lowest prices of the stock create shadows or wickers.
Many technical traders interpret a Doji candle as an indication of a trend reversal, so they choose to ‘pause and reflect’ for more convincing patterns to appear. For instance, if a Doji candlestick appears during an uptrend, it may imply that buying momentum is slowing down. But it can also be momentary indecision, and the market may continue to move in the same direction afterward. So, if you plan your strategy based on a single Doji pattern, you may get it wrong.
Doji Candlestick vs Spinning Top
Now, Doji and Spinning Tops both are quite similar in nature and feature, represent market indecision. If the real body of the candlestick is around 5 percent of its total size, it is called Doji; otherwise, a Spinning Top. When either appears in a trading chart, look for other indicators like Bollinger Bands before planning entry or exit.
Technical traders use candlestick charts to cut the noise in the market and understand price movement. However, like other tools, candlestick charts alone aren’t indicative of any change. Similarly, Doji has its limitation. The isolated Doji candlestick pattern is neutral and not a confirmation of possible trend reversal. The size, pattern, and location where the Doji formed can reveal more about changing sentiment. Some traders also find the Double Doji pattern a more convincing indication of a trend change.