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June 18, 2018

Importance of Doji in Japanese Candlestick Charts

The doji is an important reversal indicator.

A doji is a Japanese candlestick in which opening and closing prices are the same.

 

 

 

 

Doji                             Long-legged doji          Gravestone doji

It forms is a distinctive trend change signal. But, the probability of a reversal increases if subsequent candlesticks confirm the doji’s reversal potential. Please note that doji sessions are important only in markets where there are not too many doji.

Doji at market tops

Doji are valued for their ability to evoke market tops, especially after a long white candlestick in an uptrend (see example below). The reason for the doji’s negative implications in uptrends is that a doji suggests indecision.

 

 

 

 

Doji after tall white candlestick

The more conservative the trading style being used, the more important it is to wait for verification of a trend change.

Doji in a downtrend need more confirmation

On the opposite, as good as doji are at calling tops, they tend to lose their reversal potential in downtrends. The reason behind this is that a doji reflects a balance between buying and selling forces. With contradictory market participants, the market could fall due to its own weight.
As such, an uptrend should reverse but a falling market may continue its descent. That is the reason why doji need more confirmation to signal a bottom than they do at a top. This is shown in the example below.

 

Example of doji in a downtrend

Once prices broke to the downside, doji 3, 4, 5, 6, and 7 formed. But these doji were no reversal signs. The market still moved downwards after they appeared. Only when doji 8 and 9 developed a double bottom there was a (temporary) trend reversal. In summary, there may be less need for confirmation of a top reversal via a doji than for a bottom reversal.

Double-check for bearish confirmation

In the next example, we notice that confirmation after a doji increases success in projecting a trend reversal. The white candlestick, which appeared a month after doji 1, did not confirm the top suggested by doji 1. Bearish confirmation came only after doji 2. Verification came in the form of a hanging man and then a long black candlestick. Confirmation of doji 3 as a top came next month with long black candlestick session.

 

Doji at tops where confirmation is needed

Doji after a long white candlestick

The example below shows that a doji after a long white candlestick, especially after an extended uptrend, is often an upfront warning that a top is near.

  1. In August, a doji followed two long white candlesticks. After doji 1, the prior uptrend (which began with a bullish hammer on August 22) went from up to sideways.
  2. Doji 2, early November, was preceded by a long white candlestick. When this doji occurred, the temporary rally, which preceded it, ended. And within a few days, the price had broken under the late October lows.
  3. During the last few weeks shown in the chart, the price had a steep advance that pushed above the 2800 level. But note where the rally was short-circuited – after the appearance of doji 3. This doji came after a long white candlestick, which meant that the buyers, who were in control the day before (as proven by the long white candlestick) had lost control. The next day’s black candlestick increased the likelihood that the market had topped.

 

Example of doji after a long white candlestick

For non-Japanese technical analysts, if a session’s open and close are the same, there are no forecasting implications. To the Japanese, such a session, especially at the heels of a sharp advance, this is considered as a critical reversal sign.

The long-legged doji is also known as the rickshaw man

The long-legged doji is especially important at tops. If the opening and closing are in the center of a session’s range, the line is referred to as a rickshaw man. If there is a non-doji session with a very long upper and/or lower shadow with a small real body, the line is referred to as a high-wave line. A group of high-wave candlesticks is a reversal pattern.

In the following example, the long-legged doji (here, as 2 rickshaw man lines) was a major warning sign. These long-legged doji indicates a market that has lost its sense of direction. This group of small range candlesticks formed a major top.

 

Example of long-legged doji

The potential of the gravestone doji in calling tops

The gravestone doji (see below) is another distinctive doji. It develops when the opening and closing prices are at the low of the day. It can sometimes be found at market bottoms, but indicative potential lies in calling tops. The longer the upper shadow and the higher the price level, the more bearish implications of the gravestone doji.

The second doji in the chart below is the one of most interest. This gravestone doji marks the end of the battle for the bulls as the bears take over when the uptrend support line is broken.

 

Example of gravestone doji

The gravestone doji, at tops, is a specific version of a shooting star. The shooting star has a small real body, but – as it is a doji – the gravestone doji has no real body. The gravestone doji is more bearish than a shooting star.

Sometimes doji become support or resistance zones

On a final note, doji specifically at tops or bottoms sometimes can turn into support or resistance zones.

 

Example of doji as support and resistance

This concludes our overview on the doji as a potentially important reversal indicator. Next time we will explain more on trading the HitBTC market by combining Japanese candlestick charts with other technical analysis techniques.

Source: Japanese Candlestick Charting Techniques (by Steve Nison)