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The use of candlestick patterns is widespread in the stock market to understand price movements and form an effective trading strategy. Among them, the one that appears remarkable is the doji pattern, which occurs when the asset's opening and closing prices are close to one another, indicating hesitation with the direction of the trading activity in the session. Its rarity is the reason it translates to "blunder" in Japanese.
Doji candlesticks look like a cross that has a very small body and long shadows. They generally form while the consolidation is taking place and may indicate a sign of reversals or continuation of trends, depending on the market conditions.
Key Takeaways
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A doji is created when the opening and closing prices are almost equal, which shows indecision in the market.
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It can signal a possible trend reversal, particularly around levels of support or resistance.
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Variants such as Dragonfly and Gravestone Doji provide a better understanding of market sentiment.
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Always combine Doji analysis with other indicators to confirm signals and minimise false setups.
Meaning of Doji
The Doji candlestick pattern is named after a Japanese word, "doji", which means "error" because of the peculiar situation where the opening and closing prices of the asset are almost identical. This is a rare structure as it highlights hesitation in the market, signalling that neither buyers nor sellers have taken over. As a result, it often foreshadows any possible reversal, both ascendant and descendant.
For traders, recognising the Doji candlestick pattern is very important as comprehension of the chart formations across stocks, currencies, futures, and bonds is a key part of technical analysis.
Importance of Doji
The Doji candlestick pattern is very important in technical analysis because it signals market indecision. It shows times when prices reflect available information but don’t necessarily show a stock’s true value. Traders use chart patterns like the Doji to cut through market noise and identify meaningful signals.
Each individual candlestick is influenced by 4 data points - the open, high, low, and close, regardless of the timeframe used. These values form a hollow or filled-in body with the extensions above and below that form shadows.
A hollow body will reflect a higher close than open, and a filled body will reflect the opposite. Amid these patterns, the Doji pattern candlestick is an outstanding example, where its near non-existent body indicates a high degree of indecision and often precedes significant shifts in the market.
Types Of Doji Patterns
The information you get from recognising the pattern depends on when it occurs and which type of doji it is. There are five commonly defined types of doji candlesticks that indicate different trends and market climates:
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Standard Doji/Doji Star:
Standard doji candlesticks alone doesn't give clear information about market trends, but it is highly significant when viewed in context. If the Doji appears after a strong bullish candlestick in an uptrend, it might signal that the buying pressure is weakening and a reversal could occur, becoming a potential sell signal if the price falls below the Doji's low. Conversely, if the Doji forms during a downtrend, and is then followed by a bullish candlestick, it suggests that selling pressure has stalled, indicating a potential market reversal and a buy scenario.
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Gravestone Doji:
These types of doji candles have long upper shadows with negligible lower wicks and may indicate that while buyers succeeded in raising prices at first, they failed to sustain this trend at the close. If it occurs during an uptrend - particularly at the resistance or Fibonacci retracement level - it may signal a bearish reversal trend. Conversely, if it occurs on a downtrend at the support level, it may indicate a bullish reversal.
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Dragonfly Doji:
Dragonfly doji are the opposing scenario to gravestone doji with long lower wicks and minute upper shadows. They may appear at the top or bottom of uptrends or downtrends, respectively, and could indicate a change in market direction. The minuscule upper shadow indicates that the price did not rise above the open throughout the session. When they form at the bottom of a bearish trend, they often function as a bullish signal.
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Four Price Doji:
This type of doji is characterised by a single straight line with no upper or lower extensions as prices did not move either way throughout the course of the session. It may signify a high degree of indecision or a quiet market where the high, low, open and close are all at the same level, which gives the pattern its name.
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Long Legged Doji:
In these types of doji candlesticks, there are greater extensions of the wicks on either side of the chart’s body, indicating that the price varied greatly throughout the session, with stiff competition between buyers and sellers. However, neither of these groups were able to dominate the market, resulting in the formation of a long-legged doji.
Conclusion
Different types of doji may serve as useful indicators of trend reversal when spotted at the back end of uptrends or downtrends. However, they may not be as strong a signal when they occur at the initial stages of the trend. In such cases, they may simply signify indecision. It is also important to note that if the previous trend continues after a doji, it acts as a fake reversal pattern that may encourage you to continue an existing trade. It is also important to consider prevailing market conditions and other parameters for analysis when using doji patterns to conduct trades.