This article deals with one of the most enigmatic concepts in the Japanese candlestick technique theory, the doji candle.
A doji candle is forming when the opening and closing prices of the candle are the same. Most of the time a doji is calling for a top or bottom to form, but it can also act as a continuation pattern. The key in interpreting a doji candle stays with the price action to follow.
It is extremely important to understand when dojis are showing hesitation and that does not mean that price, in a bullish trend, cannot move beyond the doji’s highs, or in a bearish trend, price cannot move below the doji’s lows.
The image above shows the classical doji candle, but there can be various types of it; the so-called rickshaw man, gravestone doji, dragonfly doji, as well as northern and southern doji.
When it comes to the forex market it should be noted that it is very difficult for a candle to have exactly the same opening and closing price due to the fact that the vast majority of brokers now are offering five digits quotation and getting it right into the fifth digit rarely comes true, especially on bigger time frames.
Therefore, one should be flexible when interpreting a doji; looking for candles that have a really small body.
The chart above shows the daily USDJPY and there is a northern doji at the end of the consolidation before the extremely bullish break, confirming once again the power of such a candle.
On the other hand, look at the southern doji above, which represents clearly a bearish signal. While the market is indeed moving to the downside after that, price is still finding strength to claw back above the levels of the previous doji. However, it is only temporary as price virtually collapses afterwards, once again confirming the power of these candles.
It should be mentioned that, as a rule of thumb, a doji candle is rather a candle calling for a top than a bottom, and this means that in looking for a bottom, a doji tends to lose some reversal potential. Therefore, more confirmation is needed and one should look for either a morning star or even a hammer to come to confirm the earlier doji sign.
The chart above shows exactly what I meant in the previous statement as the doji candle in this bearish AUDUSD daily chart shows indecision but the market still travels to the downside for the next two days until another reversal pattern forms; this time a morning star.
It is all a bull wants when it comes to this market, as applying the entry logic behind a morning star, as explained here at ForexGator.com, should result in a nice profit. And the doji candle has much to do with it.
In other words, it is enough in a bullish trend to look for a doji to form while in a bearish trend it is recommended to wait for another confirmation, namely for another reversal pattern.
The usual caveat applies in this case as well, namely, the bigger the time frame analyzed, the stronger the pattern and the bigger the implications of the price action to follow. It is one thing to look at the hourly chart or even lower time frames if your analysis implies longer term trends on the daily or even bigger time frames.
As mentioned earlier, southern and northern dojis are bearish. They are to be found more often than the dragonfly or graveyard doji’s, due to exactly the same explanation with the five digits quotation.
In conclusion, no matter the type of the doji, when seen in a bullish trend, it signals hesitation and there is a big probability that the market is tired, so looking for a reversal is the logical thing to do. If not going short, at least closing eventual long positions should be wise.
With this we’ve covered here at ForexGator.com, the most interesting aspects of the Japanese candlestick techniques, starting with piercing and dark-cloud cover, continuing with morning and evening stars, bullish and bearish engulfing, and ending with the famous doji.
Next article here will deal with how to incorporate the CCI (Commodity Channel Index) when trading the forex markets in order to spot potential reversals.