Doji refers to a candlestick pattern that opens and closes at or near the same price with shares typically moving above and below the opening price to form wicks on either side.
The pattern commonly appears at the bottom and at the top of trends. As such, it is used to signify the possibility of a price reversal. The formation can also be viewed as a continuation pattern. A Doji appears as an inverted cross or plus sign and its formed when an asset’s opening and closing prices are equal over a particular time period.
Formation of a Doji
It is important to understand that every candlestick pattern requires four sets of data. These are used to define the shape as well as the position of the formation. Every candlestick pattern has an open, close, high and low characteristics. Analysts use the shape to make decisions and assumptions regarding a particular trend.
The hollow bar found on the candlestick is the body while the lines extending from the hollow bar are the wick. A security will be characterized by a hollow candlestick if it closes higher than its opening price and the same security will have a filled candlestick if the security closes at a lower price.
Types of Doji
There are a few different types of doji candles and we will cover them in more detail below.
Neutral – This is characterized by a small candlestick formation. The asset’s opening and closing prices are located at the middle of the day’s high and low. It is important to understand that the candlestick forms only when trading activity is at equilibrium.
Long Legged – As you monitor the chart, you may stumble upon the long legged Doji. This is referred to as the Rickshaw Man and it’s characterized by the upper and lower wicks being longer than the body of the candle.
The long legged doji pattern has a long candlestick where the security’s opening and closing price meet at the middle of the day’s high and low. This pattern also forms only when demand and supply are at the same level.
Gravestone Doji –
In a Gravestone pattern, a security’s opening and closing prices are at the day’s low with a long wick above showing that buyers took prices higher before being over taken by sellers right before the candle closes. This doji is usually a foreshadowing of a down move to come, hence the name.
Dragonfly Doji – The dragonfly doji forms when prices sell off and then are brought back up to where the candle opened. This is candle is most often used when a stock is in a downtrend and then you have a dragonfly doji on volume show up. It’s a great indication that prices are likely to reverse the trend and start heading up.
How To Trade With Doji
By now you already know that a doji candlestick only forms when supply and demand forces are at equilibrium. As a result, it is common for a tug of war to exist which means there will be no clear winner between bears and bulls.
Despite this, you can make the pattern work for you when trading. To ensure that you are able to profit from this pattern, you need to make sure that the pattern is at a support or resistance area.
Trade Entry – Trading off just a candlestick formation isn’t the best way to trade but when you combine with other factors like volume, price action and a stochastic or oscillator, you are increasing your chances for success.
Doji’s are best used in trend reversals where there is high relative volume on the doji candle. Once you see that you would want to wait and enter on the next candle when it breaks the high or low of the doji in the direction of the reversal. Once you are in the trade you can use the low of the doji as a stop.
Trade Exit – Like I mentioned above, once you are in the trade you can use the doji low or high as a stop and then use that risk amount to find your profit targets. It’s best to use a 2 to 1 risk/reward ration. So if you have to risk 10 cents on the trade then you should look to take profits at 20 cents from your entry.
Doji’s are great candles to know and understand and when to implement them into your trading. Once you combine them with other factors they can be a great pattern for identifying reversals and finding an edge in the market.