Candlestick charting is more popular than ever before, with a legion of new traders and investors being introduced to the concept by some of today’s hottest investment gurus. Once mastered, candlesticks can provide unique visual cues that make reading price action easier and also help the trader in identifying turning points in a trend as it occurs, before a new price trend starts. Reversal patterns in western analysis often take many periods to form but the vast majority of candlesticks formations take only one to three time periods, and give traders more of a real time picture of market sentiment.
Many traders still don’t know the major reversal patterns used in candlestick analysis and there is much misunderstanding concerning the practice. This article series will try to explain the different major candles, patterns and also when these signals are valid. We will start with the major candles and then graduate to the major reversal patterns. This is the first article in this series and we will be discussing the doji candle.
Doji’s are powerful reversal indicating candlesticks and are formed when the security opens and closes at the same level, implying indecision in the stock price. Depending on the location and length of the shadows (lines above and below the open and close), Doji’s can be categorized into the following formations: doji, long legged-doji, dragonfly doji and gravestone doji.
As previously mentioned, the standard doji consists of a candle that closes and opens at the same price level. Doji’s become more significant when seen after an extended rally of long bodied candles (bullish or bearish) and are confirmed with an engulfing candle. A long legged-doji is formed when the stock opens at a level, trades in a considerable trading range only to close at the same level as it opened. Long legged-doji’s become more powerful when proceeded by small candles, as a sudden burst of volatility in a relatively nonvolatile stock; can imply a trend change is coming. Dragonfly Doji’s are doji’s that opened at the high of a session, had a considerable intraday decline, then find support to rally back to close at the same level as the open. Dragonfly Doji’s are often seen after a moderate decline, and are bottom reversal indicators when confirmed with a bullish engulfing. Gravestone Doji’s are the opposite of the Dragonfly Doji and are top reversal indicators when confirmed with bearish engulfing candle pattern. As the name implies, gravestone doji’s look like a gravestone, and could signal impending end of a trend for a stock.
While the doji is one of the most powerful candles, it’s best to wait until the next candle for confirmation before considering a trade. The doji by itself can mean a brief resting period or beginning of a price consolidation rather than a full blown trend reversal.