One of any cryptocurrency trader’s main tasks is to minimize the risks while aiming for consistent profits. To achieve this, traders can choose from a wide range of strategies that rely on technical analysis indicators and chart patterns. One of the best, if not the most popular candlestick patterns, is the Doji candlestick. However, this formation is mainly borrowed from forex trading. However, it is quite relevant for day traders, swing traders, and traders alike. That’s because it can help them assess the crypto market situation despite the high volatility intrinsic to most digital currencies.
A Doji candle is a candlestick formation that shows up when the open and close price of a cryptocurrency ends up relatively at the same level, while the shadows are relatively long. In fact, there are different types of Doji candlestick, and this is dictated by the position and length of upper and lower shadows.
How Does Doji Candlestick Work?
If you have monitored candlestick charts, you know that candles represent one of the most convenient ways to analyze historical and real-time price action. Each candle includes data about the open, close, high, and low of a price, and the color indicates whether the price action was bullish or bearish during the given period.
Nevertheless, the candlestick chart can offer you more than just price data – it can also provide clear buy or sell signals, and Doji is one such example.
The Doji candle is quite easy to identify because it has an almost non-existent body and long shadows. A Doji formation’s function is to show traders that the market has entered a state of indecision and neutrality, which can end up with the continuation of the trend or with its reversal.
The transitional formation suggests that bulls and bears can’t decide which of them are more robust in a given moment.
Understanding The Formation of A Doji Candle
The standard Doji candle forms when the market opens in a specific direction. However, it’ll find strong resistance or support at some point and goes in the opposite direction, where it finds the same level of counteraction. In the end, it closes at relatively the same level where it opened, which suggests a moment of indecision.
For example, the market can open higher, after which bears reject the ascension and push the price back down to a certain level. As a result, the market tries to balance the situation by returning near its open. This kind of Doji is regarded as a trend continuation signal, but sometimes it can lead to a reversal. So, a trader should use other technical indicators for a more accurate indication. We will discuss several types of Doji candles that provide different signals, which may point to both continuation and reversal.
It’s worth noting that the Doji pattern doesn’t necessarily mean reversal or continuation but simply indecision. Such candles can often be seen during periods of resting following strong uptrends or downtrends. The market may continue its way after resting. However, it can also suggest that the existing trend is losing strength. It’s challenging to regard the common Doji as a powerful signal, but the pattern is definitely worth watching since it suggests that both bulls and bears more active.
Types of Doji Candlestick Chart Patterns
As mentioned, Doji candles can differ depending on the position and length of the shadows. Here are the most popular Doji formations that a crypto trader can encounter:
The neutral Doji, also called standard Doji, consists of an almost invisible body positioned in the middle of the candle, i.e., the upper and the lower shadows have similar lengths. This pattern shows up when both the bullish and bearish sentiments are balanced.
However, the standard Doji doesn’t provide any specific signal when used separately. Usually, traders consider it a trend continuation pattern, but reversals might also occur quite often after it. Thus, it is recommended to use some technical indicators that would provide more hints. If the neutral Doji comes after a strong bullish candle, investors will interpret it as a buy signal.
Also, if a bullish candlestick shows up above Doji’s high and has a higher low than the Doji’s low, it can be interpreted as a buy signal. Vice versa is valid for the bearish signal.
This type of Doji has longer shadows than the neutral one. Long-legged Doji suggests that both buyers and sellers tried hard to take control over the price action at some point during the period covered by the candle, though there was no winner in the end.
When traders spot this formation of the chart, they would closely watch the closing price concerning the whole candle’s mid-point. If the close is below the mid-point, it can be a bearish signal, especially near resistance levels. If the close is above the mid-point, it can be regarded as a buy signal, as the formation resembles a bullish pin bar.
On the contrary, if the closing price is right in the middle, it can be considered a trend continuation pattern. Hence, so you should always check the previous candles.
The Dragonfly Doji has a long lower shadow and a non-existent upper shadow. It means that the open, close, and high were at the same level. Thus, resulting in a T-shaped candle.
If such a pattern shows up at the bottom of a downtrend, it can be regarded as a buy signal. However, if the price action breaks above the high of this Doji, traders can open long positions. If the Dragonfly Doji forms near the resistance level, traders can exit positions as it is considered a reversal pattern.
This Doji type is the opposite of the Dragonfly. In this case, the open and close prices coincide with the low. Thus, we get an inverted ‘T.’ It suggests that bulls could push the price up but ultimately failed to fuel the bullish momentum.
When the Gravestone Doji shows up during an uptrend, it can be regarded as a reversal pattern, especially when seen near a relevant resistance level. Alternatively, it can act as a bullish reversal signal when it appears during a downtrend near a support level.
The 4 Price Doji
The 4 Price Doji is a unique pattern that can be observed rarely, especially during low-volume trading or on smaller timeframes. It resembles a minus-like line, which suggests that all the four price indicators, including high, low, open, and close, were at the same level in a given period.
In other words, the market didn’t move at all during the covered period. This type of Doji is not a reliable pattern and can be ignored. It merely shows a moment of market indecision.
Double Doji Strategy
A single Doji is regarded as a good signal of indecision. However, two consecutive Dojis represent an even greater pattern that can lead to a strong breakout. There is a simple Double Doji strategy that aims to benefit from this more prolonged indecision.
After the two Dojis, traders can wait for the price to move higher or lower. Then enter the market in the breakout direction. While the take profit targets can be set near a recent support or resistance level. Alternatively, you can place a trailing stop, as the new move might continue even beyond the current support or resistance.
Why Doji Candlestick Is Important for Technical Analysis?
While Doji candlesticks may not be very reliable buy or sell indicators, except maybe for Dragonfly and Gravestone Dojis, they offer traders a moment of reflection. Whenever a Doji pattern shows up, and you have open positions, you should be ready to exit the market if the price begins a reversal.
Nevertheless, Doji’s importance makes sense in combination with other technical indicators such as Moving Averages (MA) and the Relative Strength Index (RSI).
Doji Candle vs. Hammer Candle: The Differences
Doji and Hammer candlesticks might look similar because they both run into the shadows and short bodies. However, unlike Doji, which is generally pointing to indecision in the market, the Hammer candlestick usually signals that an existing downtrend is about to reverse and turn into an uptrend.
That is why Hammer candles usually come at the bottom of a downtrend. While Doji can be seen at any point. The same is true about the difference between Doji and the Shooting Star, which is an inverted Hammer and thus a bearish reversal signal.
How to Trade with Doji Candlestick?
Given that there are several types of Doji candlesticks, there are different ways to trade them. However, in most cases, you should use additional indicators, such as momentum indicators, including Stochastic.
Here is an example of a trade using a neutral Doji:
Trading With Neutral Doji
As you can see, the Doji candlestick formed after a temporary correction within a newly formed uptrend. The question is – will the upward movement continue, or will the price turn bearish? To obtain a more accurate picture, we checked the Stochastic. It indicates that there’s more room for growth, as the price action is not even close to the overbought level. Indeed, the price eventually maintained a general uptrend.
So, when you see that the Doji candlestick forms at the bottom of a downtrend or near an uptrend’s resistance, you should always check the Stochastic or the RSI indicator to get a better signal.
Ultimately, the best way to trade the Doji is to wait for the next candlestick to break above its high or below its low. Assess the indications, then only make a final decision about opening a position or closing one.
Trading With Dragonfly and Gravestone Doji
Besides the neutral Dojis, you can look for Dragonfly and Gravestone Dojis, which can provide signals independently. However, additional technical indicators are recommended anyway. Dragonfly and Gravestone Dojis are very similar to the Hammer and Shooting Star patterns, and the types of signals are similar as well.
Here is an example of a trade based on the Dragonfly Doji:
In the image above, the Dragonfly formed after a steep bearish decline. This type of Doji anticipates a trend reversal, and this happened in our example as well. Moreover, the Stochastic reached the oversold level after the bearish candle, which suggested that the Dragonfly was even more relevant. Eventually, the price started to move upwards very slowly, and then the pace increased.
When the price moves higher for a while, the chart can form a Gravestone pattern. Which is an inverted Dragonfly Doji that precedes the reversal of an uptrend.
The Risks of Using Doji Candlestick
Relying on Doji alone is not a good idea because this type of candle is relatively neutral in most cases. Plus, a trader might risk missing out on crucial information before making a trade. That’s mainly because Doji candlestick only provides minimal information.
Moreover, finding a Doji candle is not that easy, as these formations don’t appear quite frequently. Even when they show up, you should combine them with technical indicators and other tools to get a more accurate signal because Doji alone doesn’t provide strong signals.
In conclusion, Doji candlestick is not the best pattern to provide strong buy and sell signals. But it does a great job at finding moments of indecision among bulls and bears, which should alert you about the open positions or potential opportunities.
Doji candlesticks are better suited for intermediate and professional cryptocurrency traders since they can easily spot them and interpret their signals.
Is Doji Candle a Reversal Pattern?
Not really – Doji is a pattern that detects moments of indecision in the price action. It can be interpreted both as a trend continuation and reversal pattern.
Where Did Doji Candlestick Get Its Name?
A Doji refers as “dо̄ji” in Japanese is a name in which the candlestick has an open and close that are equal and often the components in patterns. When translated in Japanese, Doji means blunder or mistake. Where it refers to the rarity of an exact match of a closing and opening price. Ultimately, Doji is a transitional candlestick that primarily defines the equality and indecision of the bull and bears in the financial market.
What Does 3 Dojis in a Row Mean?
Two consecutive Dojis provide a better signal, but three Doji are even more powerful. This formation is often called Tri-Star, and it is a reliable trend reversal pattern.
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