What is the Doji Candle Stick?

A Doji candlestick in a technical trading chart typically appears when the opening and closing prices of a certain asset are almost equal. A doji candlestick pattern typically occurs in a chart in the form of a plus sign, a cross or an inverted cross.

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A Brief Definition of the Doji Candlestick Pattern

Deriving from the Japanese term ‘Doji’, which essentially means ‘the same thing’, this pattern represents the price position of securities in a similar way. During any trading day, the Doji appears when the opening price is similar to the closing price or might have a minute variation.

Suppose a stock opens at INR 500 and closes nearly at the same level, say INR 501, after fluctuating between INR 498 and INR 502; it forms a Doji.

This basically shows that neither buyers nor sellers could dominate, reflecting strong market indecision. Considering the Doji formation, its small body typically represents the almost equal opening and closing prices.

Unlike other chart patterns available for traders, a Doji candlestick has substantial shadows or wicks at both ends, reflecting a higher volatility. Continuing with the indecision, once a Doji candlestick pattern appears, the market experiences a potential reversal.

Different Types of Doji Candlestick Patterns

Depending on the formation of a Doji, there are 5 types of such candlesticks. As a trader, you must check each of them so that you can make trading decisions informedly:

1. Classic Doji

   Also known as ‘standard Doji’, it forms with the opening and closing price being the same for an asset on any trading day. If you are wondering how it is separate from other Doji types, it has a tiny body with wicks at both ends of similar length.

2. Dragonfly Doji

   This Doji candlestick typically forms when the opening and closing prices of an asset are close to its highest price on the same day. For example, a stock opens at INR 515, reaches its high of INR 520, and closes at INR 518. It might lead to the Dragonfly Doji. It typically signals a trend reversal, and bulls might take over the market as this pattern forms.

3. Gravestone Doji

   This pattern is the opposite of the Dragonfly Doji and appears as an inverted ‘T’ on the trading chart. It indicates that the stock prices have moved towards only one direction and have closed near their opening price. Typically, it forms at the top of an uptrend, but there have been instances of appearing at the bottom of a downtrend.

4. Long-Legged Doji

   When a long-legged Doji candlestick pattern appears on the chart, you can read its formation as it has a small real body. Such a Doji also has wicks on both ends. However, the lower wick of this Doji candlestick is longer than the upper wick. It indicates that the stock has closed at a much higher price point than its lower price point in a trading day.

5. Four-Legged Doji

   This type of Doji candlestick rarely appears on the chart due to a price movement exceptionally different from the others. When prices of a certain asset stay the same when it opens, reach its highest, touch its low and close, a small square forms.

Characteristics of the Doji Candlestick Pattern

Apart from the Doji types and their formation, here are some other characteristics when a Doji appears on the chart:

1. Reflects Opening and Closing Prices

   As these candlesticks typically have no real body or small bodies with wicks, they represent that the opening and closing prices are almost the same.

2. Indicates Indecision and Potential Reversal

   When it forms, traders often see it as an indicator of market indecision before trend reversals. Here, both bearish and bullish pulls are typically the same.

3. Direction Neutral

   Doji is neutral in terms of direction. Therefore, traders must analyse the market carefully to make trading decisions.

4. Confirmation With the Next Candlestick

   Dojis represent the market indecision and potential reversals. However, traders must wait for a candlestick to appear next to a Doji to confirm the reversal.

How to Interpret the Formation of the Doji Candlestick Pattern?

If you are new to trades, interpreting a Doji candlestick might seem hard for you, as it is a single candlestick, unlike a full pattern. Unlike patterns that typically occur across multiple trading sessions, a Doji accounts typically for a single trading day, i.e. for 9:15 AM – 3:30 PM.

Therefore, you must consider both the preceding and succeeding sessions of trading to understand the potential reversal.

For example, if any Doji candlestick forms at the end-point of a stronger uptrend or a downtrend, this might indicate a possible reversal of trends.

In case the Doji appears during a neutral market, it might indicate a trend continuation instead of a reversal.

Strategies For Trading with the Doji Candlestick Pattern

Now that you know what is a doji candle, you must have an idea about how to trade when it appears on the chart:

1. For Bullish Reversal

   For a bullish setup, you can set your buy entry point slightly above the top of the Doji and place a stop-loss beneath it.

2. For Bearish Reversal

   Here, you can set your sell order below the low of the Doji candlestick and place the stop loss above its high.

3. Trailing Stop

   Implement a trailing stop that helps handle exit levels efficiently. For a better context, consider the location of the Doji pattern near the resistance or support level.

4. Risk-Reward Ratio

   As a trader, you must always calculate the risk-reward ratio and evaluate whether the trade setup is worth it or not.

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Benefits of the Doji Candlestick Pattern

As you have learn the definition of what is a doji candlestick, take a look at its few benefits:

1. Signs of Reversal

   Doji candlesticks typically can provide a sign of trend reversal after a prolonged trend. Suppose a stock rose steadily from INR 500 to INR 570 and then formed a Doji around INR 570. It signals that buying momentum is weakening, and a possible reversal might occur.

2. Early Signs of Warning

   When a Doji appears on the chart, traders might take it as a warning sign of trend reversal. With such a sign, traders get the opportunity to modify their trading strategy to adjust to the potential reversal.

Limitations of the Doji Candlestick Pattern

While a Doji helps with indicating trend reversal, it typically does not provide specific timing for entering or exiting the market for traders. Also, Dojis might generate false signals that lead to wrong trading decisions.

Hence, as a trader, you must confirm the trend reversal potential with other technical tools instead of solely relying on it.

Conclusion

A Doji candlestick appears when the opening and closing prices of a security on a trading day are almost the same. It represents a balance of power between the buyers and sellers and thus represents indecision. However, to confirm a potential reversal, traders must wait till a candle appears next to the Doji.

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FAQ’s

1. What is the significance of a Doji in an uptrend or downtrend?

If a Doji appears after an uptrend and prices drop after this appearance, it signifies a bearish reversal. When it appears after a downtrend, it might indicate a potential uptrend or bullish reversal.

2. How does a Doji candlestick pattern differ from other reversal patterns?

The main difference from other sticks is that it has no real body or a very small body. Also, it appears when the opening and closing prices of an asset are almost the same.

3. What is the meaning of a Dragonfly Doji and a Gravestone Doji?

A Dragonfly Doji with a longer lower shadow represents a potential bullish reversal. Conversely, a Gravestone Doji with a longer upper shadow represents a bearish reversal.

4. Can a Doji pattern appear in any market (stocks, Forex, etc.)?

Yes, because a Doji typically appears in a market with higher volatility, such as the stock or forex market.