Doji Pattern in Candlestick Trading

Written by Navdeep Singh in Candlestick Patterns

Candlestick trading has over 40 different mainstay patterns that any security trader needs to be aware of. The doji pattern is one of the most common. Any financier or trader will tell you exactly how important the knowledge of different variations of the doji pattern can be. So after hours of complex security trading research, I’ve compiled here a complete guide to doji patterns just for you. 

What is a Doji Candle? A doji candle in candlestick trading signals an indecisive market. It appears when the open and close price of a security remains approximately the same and is generally considered a reversal pattern. 

The true questions about a doji pattern arise when you consider that it’s not strictly a reversal pattern. It appears within a variety of other patterns, and exhibits multiple variations as a stand-alone pattern as well. Each variation of the doji candle signals a slightly different market sentiment and will therefore offer different insights when incorporated into your trading decision. 

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Different Variations of Doji Candles

Doji patterns appear in 5 distinct variations:

  • The Common Doji: This particular doji appears as what resembles a cross. It signifies a stand-still between buyers and sellers. 
  • The Dragonfly Doji: This doji appears on an uptrend where the security opens low and closes on a high. It resembles a dragonfly due to its high close line and long body. 
  • The Long-legged Doji: Visually, the long legged doji resembles the common doji with the key difference being its exceptionally long legs. Much like the common doji, the long legged doji is the result of an indecisive market. 
  • The Gravestone Doji: This pattern resembles a capital “T” flipped on its head. It’s the result of a temporarily bullish market hence the long wick. However, the plummeted closing line shows an inability to maintain the bullish market. 
  • The Four Price Doji: This is the absolute rarest of all doji patterns and simply resembles an underscore “_ “. This flat, wickless pattern means there was no movement at all in the session. This is the only time we’ll speak about the Four Price Doji as it bears no weight on market trends and in terms of trading analysis has little value. 

Identifying Doji Patterns in Candlestick Trading

Candlestick trading has a number of identifiable patterns and some of them are more similar than others. Knowing exactly what to look for is step one in making the most of candlestick trading –  specifically doji patterns. 

Key Characteristics of a Doji Pattern

Because the Doji pattern has so many variations we’re going to specify the traits that they all have in common.

  • Flat Bodied: Doji patterns all represent a standstill between buyers and sellers. As such the body of a Doji is practically non-existent. On a chart, you can spot Dojis by looking at the spaces between full-bodied candles. Whether those candles are long, mid, or short are irrelevant since just having a candlestick means it’s not a Doji. 

This is the most common characteristic factor of a Doji pattern.

Interpreting Doji Pattern in Candlestick Trading

The appearance of a Doji on the price chart can mean a few different things so we’re going to break down what to do with each Doji pattern.

  • The Common Doji: The Common Doji is usually considered a reversal pattern. Its main relevance comes when it appears in an uptrend. Meaning this Doji is great if you’ve had your eye on a particular security that based on your assessment has been trading much above its intrinsic value.
  • The Gravestone Doji: The Gravestone Doji is another Doji reversal pattern. It shows that at one point the prices were driven up quite possibly as a result of an overbought security. This pattern means a bearish market is looming. If you spot the Gravestone Doji then chances are it’s time to make an exit from a bullish trade and to consider short-selling the security.
  • The Dragonfly Doji: The Dragonfly Doji is the opposite of the Gravestone Doji candle. The Dragonfly Doji shows a bounce back in a security that was on a downtrend. This pattern is considered a sign of bullish reversal, and you should therefore assess a potential bullish trade when this candle appears in a downtrend.
  • The Long-legged Doji: The Long-legged Doji shows that at some point during the trading session that this candle represents, both buyers and sellers were in control. A notable point of the Long-legged Doji is that, depending on where exactly the close ends up, it could be a reversal or a continuance of an uptrend. If the closing price is below the middle then this signifies a potential downtrend. Conversely, if the close is above the middle then this could be an indicator of a bullish market. 

Improving Reliability of Doji Pattern in Candlestick Trading

The Doji Patterns, like any other candlestick pattern, should rarely be taken at face value. While they can be a solid predictor for market trends they are best when paired with certain indicators and an overall knowledge of certain market factors.

Examples of complementary tools in technical analysis that can be leveraged to improve the reliability of Doji candles in trading are as follows –  

  • Bollinger Bands: Because Doji patterns are defined by their connection to closing price, Bollinger Bands form a complementary duo with them. Bollinger Bands can be used to identify strong support and resistance zones of any potential trends. Hence, you can leverage this indicator to root out oversold or overbought securities. Finally, combining these insights with a Gravestone or Dragonfly Doji can offer much better insight into forecasting the potential changes in existing price trends.
  • Fibonacci Retracements: A Long-legged Doji or a Common Doji both show a consistent overall balance between buyers and sellers but when used with a Fibonacci retracement they can show the overall trend of a security, i.e. bullish or bearish. 

How to Trade Using Doji Candles?

Now that we are done discussing the basics, let us jump straight into the business and discuss how you can trade using the Doji Candles. 

While there are many different strategies that experts have formulated around the doji pattern, I have found the End-of-Day Trading Strategy to be exceptionally reliable. Described in the following section are the various steps that you should consider when trading End-of-Day Strategy using the Doji Candles.

Market Environment

The End-of-Day Trading Strategy works perfectly on a particularly volatile market when combined with knowledge of Doji patterns. This strategy will allow you to target certain set fluctuations in a volatile market by charting stagnate days with the Doji and plotting a Fibonacci retracement. You’d be able to see the consistent movements within a volatile market. If you were to then make entry based on the End-of-Day Trading Strategy, then early morning price changes would be in your favor.  

Identify and Confirm Trade Opportunity

Two of the best variations of the Doji to look for are the Gravestone and the Dragonfly when using the End-of-Day Trading Strategy. However, remember to back up the Doji pattern with indicators and the trend patterns of your particular market. Several complementary tools in technical analysis that work really well with this strategy are discussed as follows – 

  • Fibonacci Retracement and Extension Levels: These levels are at the center of the Doji Candle End-of-Day Trading Strategy. The position of the Doji with respect to a critical Fibonacci retracement level reveals important information with regards to the reliability of the trading signal generated by this pattern. If the Doji appears at an important Fibonacci level, the identified trade is considered relatively reliable. Whereas, when the Doji candle appearance is not coincided with a Fibonacci level, the trading setup is considered to be very strong.
  • Momentum Indicators and Divergence: Divergence and overbought/oversold readings produced by momentum indicators (such as – RSI, MACD, Stochastic Oscillator, and Williams %R, etc.) can serve as reliable confirmation signals for trades identified using a Doji Pattern. When the appearance of a Doji Pattern coincides with a divergence or a strong overbought/oversold reading from a momentum indicator, a reversal in prevalent price trend is often likely.     

Determine Trade Entry, Stop Loss, and Take Profit Levels

With the End-of-Day Trading Strategy, the Fibonacci Retracement and Extension Levels play a pivotal role in determining the entry and exit targets for your trades. Described below is how you would determine the trade entry, stop loss, and take profit targets under this strategy – 

  • Trade Entry: In this strategy, you will only enter a trade when the appearance of a Doji candle coincides with the price being at an important Fibonacci level. When this condition is fulfilled, in case of a bullish trade, you will enter a trade when the price exceeds the top wick of the Doji. Similarly, in the case of a bearish trade, you will wait for the price to break past the lower wick of the Doji before entering the trade. 
  • Stop Loss: In the case of a bullish trade, the stop loss for your trade will be placed a few points below the Fibonacci Retracement level, under the lower wick of the Doji candle. Similarly, in the case of a bearish trade, your stop loss will be placed a few points above the Fibonacci Retracement level above the upper wick of the doji candle. 
  • Take Profit: For most part, Fibonacci Extensions provide a reliable way to determine the take profit targets when using the End-of-Day Trading Strategy using the doji pattern. In my personal trading experience, I have found the 1.27% and 1.618% Fibonacci Extension levels to be the most reliable ones for this purpose.

Execute and Manage Trade

Doji patterns can be solid starting points for an even mix of bullish and bearish markets. The issue being that they appear on essentially any session is mitigated by the fact that in particularly volatile sessions they can often be the only consistent marker. Here executing and managing traders based on this patterns, here are a few additional things that you should consider being mindful of – 

  • Market Context: If you’ve seen this one before then it’s because it can make all the difference. An innate understanding of market context is the difference between weekend traders and fulltime investors. Correctly charting the right doji patterns can add to an unrivaled insight. Buy consistently bullish markets when you know them to be low and then turn them into long term investments. 
  • Don’t be Tricked into Using End-of-Day Data for Day Trading: The benefit of End-of-Day Trading in combination with doji patterns is to pick out the meaningful movements of a session. It skips over the chatter data. That means if you apply these broad stroke methods to the moment to moment movement you run the risk of entering too early, buying too high, and more. 
  • Pay Attention to the Prevalent Doji Variation: After you enter a trade it’s a good idea to begin charting the doji pattern that appears the most. If it’s inconsistent with the doji patterns that were prevalent before you entered, then it may be a good idea to leave as the market seems to be shifting on a fundamental level. 

Advantages and Limitations of Trading Doji Patterns

Now that we have covered the basics, let us discuss some important advantages and disadvantages of making trading decisions using the doji patterns.

Advantages of Trading Doji Patterns

Listed below are few important advantages of trading the doji pattern – 

  1. In candlestick trading, it is one of the most reliable reversal indicator
  2. It can indicate a potentially volatile market by revealing unpredictability in standard trends
  3. It indicates market psychology and the momentul control struggle between the bulls and the bears in the market quite accurately

Limitations of Trading Doji Patterns

Listed below are few important advantages of trading the doji pattern – 

  1. It appears too frequently on the price chart to be taken seriously as a standalone indicator
  2. It can’t explain why a security is fluctuating

Author’s Recommendations: Top Trading and Investment Resources To Consider

Before concluding this article, I wanted to share few trading and investment resources that I have vetted, with the help of 50+ consistently profitable traders, for you. I am confident that you will greatly benefit in your trading journey by considering one or more of these resources.

Conclusion

The doji pattern is a multi-purposed pattern that can help reveal the underlying trends of a particular security. Doji patterns are definitely a strong tool in the arsenal of any trader. Remember that every move is risky, but you can lower the risk with the right data. Chart your patterns accordingly and check out our other in-depth candlestick trading guides. 

BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!

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    Navdeep Singh

    Navdeep has been an avid trader/investor for the last 10 years and loves to share what he has learned about trading and investments here on TradeVeda. When not managing his personal portfolio or writing for TradeVeda, Navdeep loves to go outdoors on long hikes.

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