The dragonfly doji is a candlestick pattern used in technical analysis to signal a likely positive reversal in a preceding downward trend. A dragonfly doji occurs when the high price, open price and closing price are all the same, generally at the top of a significant downtrend throughout the day’s trading.
The return of the closing price to the high of the day’s open price is interpreted as a capitulation of bears and a signal that the next day’s selling will likely have a strong positive uptrend driving it.
Identifying a Dragonfly Doji
A dragonfly doji is one of the less common signals in technical analysis, so it is rarely open to a great deal of interpretation when identified.
The strict requirement for the same open, high and closing price makes this a rare signal in technical analysis. However, the additional requirement of some substantial downward momentum throughout the day is open to some interpretation.
This ‘body’ of the signal needs to demonstrate that whatever remaining downward pressure the security was experiencing has run its course and that sellers have closed their positions.
Therefore, potential dragonfly dojis with small bodies may sometimes be interpreted as too weak a signal to indicate a strong uptrend on the following trading day.
Trading with a Dragonfly Doji
The dragonfly doji is considered to be one of the best signals to identify when day trading because of its rarity, clarity and strong indication of a coming uptrend.
Very rarely will a security’s opening, high and closing price all be the same. Therefore, a dragonfly doji is a very rare technical indicator that sends a strong signal about seller capitulation.
The clarity of a dragonfly doji indicator is also seen as a strong positive. Very rarely does it open to much interpretation, unlike the case with many other technical indicators.
Finally, it is considered to be one of the strongest indicators of a positive reversal in a security’s price trend. The capitulation of the sellers signaled by the dragonfly doji is a clear indicator that the next day’s trading is likely to a have a strong positive momentum.
A dragonfly doji as the downtrend in a security trails off is generally taken as a clear signal that the bottom of a downtrend has been reached and that subsequent trading will carry a strong uptrend for quite some time.
The only issue with trading a dragonfly doji is when it does not occur as part of a strong downtrend. The dragonfly doji is such a strong signal in technical analysis because of the very specific information that it signals. If there is no preceding strong downtrend, then the itcannot signal seller exhaustion, making the meaning of the signal ambiguous or nonsensical.
Traders should ensure that there is no alternate explanation for the existence of the dragonfly doji, such as a relevant piece of news on that day, and that the signal occurs on a substantial downtrend before using the signal as a trading indicator.
As with any indicator in technical analysis, the more additional analysis and research that is done to support a trade, the stronger the use of the dragonfly doji becomes. Additional analysis can confirm that a downtrend may be oversold or has run its course, which makes it a technical confirmation for fundamental analysis or for other technical indicators.
However, the it is considered to be one of the few technical indicators that can largely be traded on its own, as long as it occurs along the proper place in preceding downtrend.
The dragonfly doji is one of the rarest and strongest technical indicators of an upcoming positive reversal for a preceding downward trend in a security’s price. While additional analysis is always valuable in day trading, the dragonfly doji represents one of the few technical indicators that can largely be traded on by itself.
As long as traders ensure that the dragonfly doji is in the appropriate place on a downward price trend where it clearly signals seller exhaustion, then it is a generally safe indicator that the subsequent day’s trading will have a strong positive momentum.