Doji Candlesticks in Technical Analysis

 

Hello there this is tradingpedia.com and this video deals with one of the most interesting and curious Japanese candlesticks patterns – the Doji candlestick. It is a tricky pattern because it signals uncertainty, meaning that the market may move in the same direction but also meaning that it may reverse aggressively.

Doji Candlestick – Basic Principle

The basic principle behind the Doji candlestick is that it looks something like this, like a cross. Depending where it forms, there are various types of Doji candlesticks, but more or less they all show the same thing – uncertainty. So whenever you see a candlestick like this, it signals uncertainty. The bigger the timeframe, the bigger the uncertainty.

Doji candlesticks on some timeframes are very tricky, and I will explain here why. First of all, a Doji candlestick has the same opening and closing prices, meaning that it has literally no real body.

But on the currency market this is tricky because the currency market has quotes with five digits, with the exception of the JPY rates that have three. It is very difficult to have the exact opening and closing price on a currency pair like the EURUSD as the fifth digit in the rate changes very fast. Therefore, one needs to be very flexible when interpreting Doji candlesticks especially on the lower timeframes.

Also it is literally impossible to have the same closing price on the weekly or monthly chart. In order to have a true Doji candlestick and assuming that the week opened at 1.18416. For the EURUSD to form a true Doji candlestick, it must close exactly at the same level – 1.18416. What are the chances for this to happen? Very slim. Not that it is impossible, but very slim.

Therefore, we need to be a bit more flexible and accept as Doji candlesticks even candlesticks that do have a small real body. Like this one here – this is Doji candlestick, even though there is a difference of six pips between the opening and closing prices.

The Timeframe

Another thing to consider is the timeframe. This is the daily chart, but on brokers that show the Sunday candlestick, every five candlesticks you will have one small candlestick that resembles a Doji, but we should not consider it as a Doji candlestick because it shows only the trading activity for a few hours on Sunday. Therefore, it would not be correct to interpret it as a full daily candlestick.

Let’s try to find out on this chart a candlestick that resembles a Doji and try to trade it. Remember what it signals – uncertainty.

This would be one Doji candlestick that acted as a reversal pattern. This is also of a particular importance because the market fell, formed a bearish candlestick, one Doji candlestick and a bullish candlestick that retraces more than 50% into the territory of the previous one – this is called a morning star.

Let’s look back in time where do we have more Doji candlesticks. Here, for example. The real body is very small, forming on the lower part of the candlestick, as it has a very short lower shadow and a very long upper shadow.

This is called a Southern Doji, and it is a more powerful reversal pattern. When the cross forms here, and the Doji candlestick has a smaller upper shadow and a longer upper shadow, that is called a Northern Doji.

When a Doji candlestick has very long upper and lower shadows it is called the rickshaw man. It also shows uncertainty, in the sense that the market prepares for a breakout.

So, Doji candlesticks reflect uncertainty, consolidation, but also continuation. In this case this Doji consolidation reflects consolidation, the market bounced from these levels to 1.12 based on one simple candlestick.

If we are to generalize what a Doji candlestick stands for, that is a reversal pattern. Have a look here – this is a Doji, the market bounced, this is another, a rickshaw man that acted as a continuation pattern. Whenever you see such a candlestick on the bigger timeframes, watch for the price to break its extremes, put a stop loss at the lows, in this case, and go for a risk-reward ratio of 1:2.

It is also useful to wait for the price to break the edges of a Doji and to wait for the market to close the period before going long or short.

Conclusion

To sum up, Doji candlesticks show uncertainty; they can act either as a continuation or reversal pattern; wait for the price to break the range of the Doji candlestick before going long or short; have a stop-loss at the opposite side; go for a risk-reward ratio of minimum 1:2; think of the Doji candlestick in combination with other patterns to provide more confidence in a trade.

Thank you for being here and bye bye.