Among other Japanese Candlestick patterns describing the price action on different charts, Doji candle is one of the most widely-used reversal signals. Based on that, a Doji Candle Strategy was developed, allowing Forex traders to identify the potential end of the recent trend and a possible reversal of the price action shortly.
Thanks to the informative chart view, Japanese Candlesticks chart make the technical analysis much easier compared to the traditional line on the price chart. The main power of candles is that they show four parameters in one single bar - open, high, low and close (OHLC) rates. Those four figures reflect the price action inside the given period more effectively than a single number indicated in the line - close price. Thus, comparing the difference between OHLC rates, a Forex trader can easily imagine what was happening during the chosen period in terms of the eternal fight between the bulls and the bears.
Imagine a price action leading to a sharp spike of the price in the first half of the day and a U-turn action after reaching some important level. Imagine the bulls were trying to continue the recent uptrend, got stuck at some point, and the bears pushed the price back to the same level the day opened. Such a scenario suggests that a strong technical or psychological resistance level has been reached, and the recent uptrend faced a tough challenge to keep lifting the price higher.
What is a doji candlestick?
If a candlestick chart looks like a cross, or a plus sign or an inverted cross, it is called Doji. Doji means a miss or an error in Japanese and rice traders used that sign as an effective tool to predict possible saturation of the markets in terms of upside or downside potential. Therefore, Doji Pattern is an effective tool to forecast changes in the markets sentiment.
Types of Doji Candlestick Patterns
There are several types of Dojis depending on the direction of the recent trend. A candlestick chart with a long upper shadow, small or absent lower shadow and relatively small or absent body is called a Gravestone Doji Candle. It usually shows that the recent uptrend might come to an end.
Below is an example of a Gravestone Doji on some chart screenshot:
The long upper shadow is a must for the Gravestone Doji formation. It shows how strong the bears were at some point as they were not only able to withstand the buying pressure and absorb all of the buy-orders from the bulls, but also push the price lower at some point. The lack of bullish momentum forced buyers to retreat, while the sellers gained the power to close the day (or another period) near the open rate. As a result, there was no significant development of the recent uptrend.
Long Legged Doji usually has long shadows on both sides, while the body is also absent meaning that open and close rates are equal. This type of bar might point to the indecisiveness of the market players and further consolidation sideways range in the future. It looks like in the screenshot below.
Finally, Dragonfly Doji has a long downside shadow and small or absent upper shadow, and again, small or absent body. It has the same meaning as per the first type, but the direction of the previous trend is different. So it could show a bullish reversal after a bearish trend. See the chart below as an example of Dragonfly Doji.
Of course, like any other single candlestick pattern, Doji needs confirmation by further price action. In case if the upcoming bar is in the red, it might signal a deep bearish retracement if not a long-term reversal. Therefore, Doji Candlestick Pattern has to be implemented as a primary signal to pay attention to, but not a signal to act immediately. Additional technical tools and indicators can be used to confirm or deny the preliminary reversal signal. Further price action is also used in the technical analysis as pure action is the only resource to understand future market’s intentions.
How to trade with Doji candlestick pattern?
The main application of a Doji Candlestick is to send a signal to a trader that something is wrong with the current trend. Such a bar appears when bull-bear relation is getting shifted compared to previous periods. Therefore, Forex traders should pay attention to any asset if a Doji is performed on the price chart. In most cases, that does not necessarily mean a sharp and total reversal of the previous trend. Dojis point to a large likelihood of such an event. Besides, a short-term retracement could also take place, and the previous trend could be renewed after that. So traders and analysis should consider those signals as a primary sign to make an in-depth analysis. For instance, if the following candle after the Doji was able to close above/below the previous bar, then the bearish/bullish reversal is more likely.
Best time frames for Doji Candles
The most effective period for the technical analysis in Forex trading is the one day chart. The reason is simple as 24 hours include all of the three trading sessions and reflects the whole cycle of trading operations in the market. Besides, daily charts are the most commonly used for technical analysis in terms of indicators. And, of course, trends on daily timeframe are much more significant and powerful than on intraday periods.
What does a doji candlestick mean?
Context is extremely important in any Forex analysis and Doji is not an exclusion. In case if a Gravestone Doji was formed after a strong uptrend, while the pace of growth of security slowed down before that, the likelihood of a bearish reversal is high. However, if the same candlestick appeared inside a sideways range, there’s nothing to reverse, and the meaning of it will be less informative.
The key informative message that markets are trying to send when charting Dojis is that the momentum is getting exhausted. That is related to occasions when a strong trend was noticed previously. A weaker momentum suggests that counter-trend forces might reverse the price action. To confirm that suggestion, FX traders should add a momentum indicator to the price chart to double-check the preliminary information received from the Doji. For example, the Average Directional Index or True Strength Indicator might be useful to determine that.
Using a Doji Candlestick with technical indicators
Besides momentum indicators, it’s worth assessing overbought or oversold conditions before making the trading decision based on Doji Candlestick chart Pattern. Oscillators will help to do that. The relative Strength Index, Stochastic RSI or Commodity Channel Index are among the most widely-used technical indicators to check out the level of overbought or oversold conditions.
Envelope indicators such as Bollinger Bands or Keltner Channel are also useful in terms of effective analysis of Doji Forex cases. In case if a Doji closes inside the Bollinger Bands but closer to the top or bottom of the range, while the shadow crossed those lines, that could empower the likelihood of a reversal. Below are several examples of Doji Candlestick Patterns confirmed or denied by technical indicators.
Adding short positions at the end of the bullish retracement
AUD/JPY was in a long-term downtrend on the daily chart below. After a short-term bullish retracement, a Gravestone Doji was formed. The upcoming candlestick confirmed a sell-signal as 13-days Relative Strength Index remained below the threshold of 50 points, while the Average Directional Index switched the sentiment to negative. Although the overall momentum was getting weaker, according to the ADX mainline, the downtrend continued. In this case, the Doji signalled and confirmed the end of the upside correction.
If you like this strategy, you might also be interested in this Heiken Ashi Strategy
No confirmation after Doji candlestick
In the case shown on the daily chart below, technical indicators and further price action denied the trading signal came in from a Doji candlestick due to several factors. First, it does not reverse anything as there was no strong downtrend before. Second, the following candlestick was green. Third, the middle BB line was not breached by the daily close rate. Fourth, Williams %R oscillator did not cross the level of -50%.
Doji candle signal was not confirmed
EUR/GBP charted several green candles before the Gravestone Doji was formed on the daily chart below. However, the following candle did not confirm the bearish reversal as it failed to close below the previous green candle’s close. What’s more, BB %B oscillator was above the middle line, pointing to bullish conditions. Stochastic RSI had both lines heading north without a bearish cross. Therefore, the Doji candle signal was denied by technical indicators and no deal was opened.
Examples of profitable trades based on Doji Candle
Long EUR/JPY after Dragonfly Doji
Before the Dragonfly Doji appeared on the daily chart below, EUR/JPY was consolidating losses with a mostly bearish bias. Although the following candle did not close above the previous one, the long positions were opened as Commodity Channel Index went off the oversold zone, while True Strength Indicator was pointing out a positive sentiment as its lines were above the threshold. The stop-loss was set at the lowest daily price of the green bar. The profit was taken after CCI went into the overbought zone.
Two Dojis Candle in a row
USD/CAD was in a 10-day uptrend after bottoming out and two Doji Candle Patterns formed. On the next daily candle, a short position was opened as Stochastic RSI performed the bearish cross in overbought territory, while ADX shifted the surplus to negative. The stop-loss order was set 5 pips above the recent high. The profit of 27 pips was taken manually after Stochastic RSI charted an opposite crossover.
Doji candlestick is a single pattern with effective and informative application in Forex trading. It is widely used to determine possible reversals of the recent trend, find moments when the trend’s momentum is getting exhausted, as well as point out assets to attract closer attention of traders. As long as the formation has only one bar, it has to be watched closely in terms of the context. Before making a profitable trading decision, analysts should check out the following candle and wait for a confirmation from other technical indicators. Any Forex deal has to correspondent with money management rules and profit/loss ratio. So traders should assess possible stop-loss and take-profit orders before opening deals based on Doji analysis.