Chart Patterns: Doji
What Are Japanese Candlesticks?
The doji candlestick pattern is a neutral market indicator. Structurally, the doji is a single candle that consists of an open, high, close and low. Dojis occur when a candle's closing price is equal to, or are very near, its opening price.
One of the oldest and most popular forms of technical analysis is known as Japanese candlestick charting. Dating back to 18th century Japan, candlestick charting techniques were first developed as a method of analysing price movements in domestic rice markets. A prominent rice trader of the period, Muneshi Homma, is credited with inventing the guiding principles for modern Japanese candlestick charting techniques.
For over 300 years, candlesticks have remained a respected and viable technical analysis approach. In contrast to line, point and figure, and open-high-low-close (OHLC) charts, candlesticks record pertinent market data points as well as provide a visual illustration of buying and selling activity.
A candlestick records five important pieces of market information that define price action for a specified period:
- High: The highest traded price, or the top of the trading range
- Low: The lowest traded price, or the bottom of the trading range
- Open: The first price traded at the beginning of a candlestick formation
- Close: The last price traded at the end of a candlestick formation
- Market Direction: The distance between the high and low of a candlestick, as well as the relation of the closing price to the open. A candlestick is bullish if it closes above its open, and is bearish if it closes below its open.
A candlestick consists of a body and tails (also known as wicks). The body of the candlestick is the range between the open and close. The tails of the candlestick represent the distance between the upper and lower extremes in relation to the body.
What Is A Doji Candlestick?
A doji is a candlestick that has a closing price that is very near to its opening price. The anatomy of the doji is unique to other candlesticks, in that the range of its body is very small or nonexistent. Often, the entire body of a doji can be represented by a single horizontal line, closely resembling a cross or an addition sign. The length of its tails, or the vertical range of the candlestick varies depending upon the magnitude of price action outside of the open and closing price.
What Does Doji Tell You?
With respect to other forms of technical analysis, the message of the doji to traders and investors is simple: indecision is ruling the market. In Japanese, the term doji means "blunder" or "clumsiness." As it pertains to the candlestick chart, the doji suggests that both bulls and bears are at least temporarily incorrect as price has found a point of relative equilibrium.
First and foremost, the doji candlestick pattern tells the trader that the market is choppy, compressed, and neutral. No matter if you are viewing the dragonfly doji, gravestone doji, or long-legged doji, one thing is certain ‒ periodic price action is non-committal. This means that the broader market sentiment is divided among buyers and sellers, as neither bidders nor sellers are able to assume control.
By itself, the doji does not indicate overbought and oversold market conditions or suggest trend continuation or reversal. Assorted types of doji candlestick differ from indicators such as oscillators and support & resistance levels because they aren't calculated mathematically. However, when placed into the context of a trending market or multi-candlestick formation, the doji candlestick pattern carries various unique connotations.
The doji is one of the most readily identified chart patterns among technical traders. They are seen to be a neutral pattern, in that both the bulls and the bears failed to move the prospective market substantially higher or lower during the specified period. A doji is often an indicator of a pending breakout, as the formation itself signals a compression of price action and consolidating market conditions.
Technical forex traders and chartists interpret the doji in a number of different ways. On a stand alone basis, the doji can be seen as a momentary pause in a longer term trend, or possibly an exhaustion point in price action. When used as part of a more complex chart pattern, the doji can function as a signal of market reversal, align a trade's stop-loss and profit target, or to identify a pending breakout. Morning stars and evening stars are examples of the doji candlestick being used within a larger chart pattern.
How to Trade the Doji Candlestick
One of the great things about building a trading strategy around the doji is the flexibility afforded to the user. Although the doji candle technically signals neutral market conditions, it may be traded in a number of different ways. A few of the most powerful are in projecting a bullish reversal or bearish reversal, as well as in trading breakouts.
Below are a few strategic variations of the doji.
A bullish reversal occurs when price retraces within a broader downtrend. To capitalise on such a scenario using chart patterns, traders search for the bullish doji star formation. The bullish doji star is a three candlestick pattern; it consists of two consecutive negative candles followed by a pronounced doji candle. When it's spotted, traders may buy into the market as periodic closing prices are likely to move higher as bearish pressure recedes. The bullish doji star may be traded on any intraday timeframe or throughout the trading day(s).
A bearish reversal develops when price pulls back amid a strong uptrend. In order to make money from a bearish reversal, traders look for opportunities to sell or "short" the market. One especially useful candlestick pattern for identifying selling opportunities is the evening star. The evening star is a three candlestick pattern; it consists of a large bullish candle followed by a doji and a large bearish candle. Upon identifying the evening star, active traders may sell in an attempt to cash in on falling prices. Bearish reversals may be traded using the evening star on an intraday or swing basis.
At its core, the doji is classified within the realm of neutral technical indicators. Accordingly, it frequently appears during periods of market compression and consolidation. In this way, standard dojis, as well as those with a long upper shadow or long lower shadow, qualify as potential breakout signals.
Before you start trading any strategy, it's important to understand that fundamental and technical analysis is best executed within the framework of a comprehensive trading plan. To be successful, any trading methodology must complement the trader's available resources and goals. If not, the chances of achieving long-term profitability are minimal.
Is Doji Bullish or Bearish?
The doji candlestick formation signifies market indecision and neutrality; it is not inherently bullish or bearish. However, within the context of a multi-candle pattern, strong market volatility, or a steep trendline, the doji may be viewed as either a bullish or bearish trading indicator.
An example of this functionality is illustrated by the dragonfly doji reversal pattern. Depending upon where the dragonfly doji pattern develops ‒ beit in the midst of a bullish or bearish trend ‒ the formation may be interpreted as either a bullish or bearish trading signal. Ultimately, the location of the doji or doji pattern in the broader market determines whether it may contribute to a trader's neutral, bullish, or bearish bias.
Types Of Doji
There are five distinct types of doji, each with specific characteristics. Each variety of doji is interpreted by technical traders to be a sign of unique market conditions, and potentially different price actions.
The five types of doji are as follows.
1. Standard Doji
The standard doji is a basic cross formation with equal length tails. As stated earlier, a standard doji is a neutral pattern, and when used within the context of a larger pattern, is a useful tool in predicting market reversal. The price movements of a standard doji are modest, thus resulting in neither a long upper or lower shadow.
2. Long-Legged Doji
The long-legged doji consists of extended tails above and below the opening and closing price, signaling the presence of an active market and potential directional move. The elongated tails represent a large trading range for a specified period, and when coupled with extreme volume, the long-legged doji can serve as a market entry point for technical traders looking to capitalise on market breakout, reversal, or continuation.
3. Dragonfly Doji
The dragonfly doji candlestick has an elongated lower tail with no upper tail. The open and close of the candlestick represent the extreme top of the doji. It is a signal of a potential price reversal. For instance, a dragonfly doji occurring during a strong downtrend is seen to be an indicator that selling has been exhausted and that buyers have taken over the market. Typically, a reversal in the trend is predicted, coupled with a bullish move in price.
4. Gravestone Doji
The gravestone doji is the reverse of the dragonfly doji. It exhibits an elongated upper tail, an absent lower tail and the open/close falling on a horizontal line. The open and close of the candlestick act as the extreme low of the doji. The gravestone doji is most valid when occurring during an uptrend. The long upper tail represents a failure in buying action, as buyers could not sustain the rally above the opening price, signaling an end to the uptrend.
5. 4-Price Doji
The 4-price doji is unique in that the high, low, open and close prices are the same. No tails are present, and the visual similarity is to that of a subtraction symbol. The 4-price doji is a sign that markets are in extreme consolidation and can serve as an indication of a coming breakout or period of market stagnation.
A doji is a Japanese candlestick chart pattern. It is a single candle formation that features a periodic closing price that is very near to its open. The doji is classified as being a neutral market indicator however, it may be interpreted in a variety of ways in concert with the prevailing market state. Dojis are powerful indicators and are used to trade bullish reversals, bearish reversals and breakouts.
Dojis are present in many multi-candled formations such as the bullish/bearish doji star and the morning/evening star. On a standalone basis, the doji comes in five types: standard, long-legged, dragonfly, gravestone and 4-price.
Each of the aforementioned doji chart patterns are applicable to the trade of shares, forex, futures and CFDs. In addition, they may be readily combined with additional technical tools such as Bollinger Bands, moving averages or the Stochastic oscillator.
If you're confused by the verbal descriptions of these items, don't worry — dojis are visual indicators. Through a bit of practice using charting software, anyone can learn to identify and interpret the different types of dojis. A great way to begin working with these robust indicators is through opening an FXCM demo account.
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