Candlestick trends are essential technical tools especially for forex traders as they give insight into market sentiment and identify support and resistance levels. Of the candlestick patterns, the doji is one of the most vital and revealing signals.
A doji is a single-candle pattern which is formed when prices open and close at the same level or at least nearly in a specific timeframe, and appears at the end of an extended trend. Its form essentially creates a cross formation.
It signifies equilibrium between supply and demand, an indicator that neither the bulls nor the bears are taking over—a state of indecision. It also implies that the trend may be ending. According to Investopedia, the doji occurs because neither buyers nor sellers seem to have gained control of the market during the day, accumulating for a trend reversal.
There are four types of doji:
· Doji star (standard) - Doji in an overbought or oversold condition implies a high probability for reversal.
· Long-legged doji - composed of long upper and lower shadows. Throughout the period, the price moved up and down dramatically before it closed at or near the opening. This reflects the great indecision between the bulls and the bears.
· Gravestone doji - formed when the open and the close occur at the low end of the trading range. The price opens at the low of the day and climbs from there, but by the close the price is back down to the opening price. A Gravestone Doji found at the top of the trend is a specific version of the Shooting Star. At the bottom, it is a variation of the Inverted Hammer.
· Dragonfly doji - occurs when trading opens, trades lower, then closes at the open price which is the high of the day. At the top of the market, it becomes a variant of the Hanging Man. At the bottom of a trend, it becomes a specific Hammer. An extensively long shadow on a Dragonfly Doji at the bottom of a trend implies a very bullish trend.
Doji Trading Reminders
The Japanese says to always take notice whenever a doji appears. A rational law of candlestick followers is that when a doji forms at the top of a trend, in an overbought area, sell straightaway. Conversely, a doji found at the bottom of an extended downtrend entails buying signals the next day to confirm the reversal.
Here is a sample of an hourly timeframe of USD/CAD, showing multiple doji candles that had reversed treneds.
After a long uptrend, a doji formation can be a warning that the trend has peaked or is close to peaking, and vice versa. When assessing a doji, be mindful of where the doji occurs. If the security you’re observing is still in the early stages of a trend, then it is not likely that the doji will mark a top, but rather, it could precede a pause in the current trend move. It can also be considered as a pivot.
Additionally, traders should not take action on the doji alone. Wait for the next candlestick to make an appropriate trade, and using other indicators such as the Bollinger bands will make your trading decisions more precise.
Trading a Doji Breakout
A doji is only significant after a stretched move to the upside for a short setup, or an extended move to the downside for a long setup. The doji should also be at a support or resistance area.
The ideal method is to find a doji that has appeared near a level of support, such as that of a trend line. You want to recognize the doji high and the doji low as this will define the support and resistance levels of a potential breakout.
Afterwards, you would want to wait for a full-bodied candle to close either above the doji high or below the doji low. Since the bulls and bears have been at a stop, a high volatility breakout should happen to release the pressure. If you get a breakout below the doji low, mark a stop about 4 pips above the doji high and enter short on the close of the breakout candle. Compute the doji range and multiply that times two to get the limit.
Since your stop is the range itself, you want to target double your initial risk.
If the opposite happens— a full-bodied candle closing above the doji high— enter long at the close of the candle and place a stop 4 pips below the low of the doji. That is your prompt to get long.
However, some dojis during periods of low volatility, like those in the Asian session, trigger numerous false signals.
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