Basic concepts
To explain what is a Doji candle, first of all, we should explain what these Japanese candlesticks are. However, before we give the concept of Japanese candlesticks, first of all, it is worth understanding the concept of technical analysis. In other words, let us start with the beginning and gradually get to the main point.
Almost from the first days of the stock exchange, no matter whether it is stocks, securities, or cryptocurrency, traders have set a goal - to make as much money as possible. To make money on the exchange, it is necessary to know whether the price of the selected asset will go up or down to profit from its movement. This is what technical analysis was created for. Simply put, it is the study of stock exchange charts to determine the movement of exchange rates in one way or another.
Its basic definitions and rules were systematized by John Murphy, the author of one of the most famous books on the topic - "The Technical Analysis of the Futures Markets. Theory and Practice." Murphy writes that its basics can be found in the theory of Charles Dow. Dow is considered the ancestor of technical analysis: he published his ideas about the stock market in a series of articles in the Wall Street Journal in the 1890s. He died in 1902 and never compiled his ideas into a book. Dow's followers collected his thoughts and published the books "The Stock Market Barometer" and "Dow Theory."
Technical analysis is the study of the history of prices and trading volumes to identify patterns. It predicts future price movements based on historical data.
There are two directions in technical analysis:
- Recognition of special situations - shapes or patterns.
- Using indicators.
And now that we have these definitions figured out, we can say what a Japanese candlestick is. It is one of the most informative chart elements that traders use.
From the name, it is easy to guess that these candlesticks come from Japan. Very clever local rice traders used this method already in the 18th century. According to some reports, the first chart in the form of a sequence of "candles" was invented by Homma Munehisa to visualize the value maximum and minimum for a certain period, as well as prices at the beginning and end of this period. However, due to the geographical remoteness and closeness of Japan to other countries, this type of chart became popular much later, when stock exchange life was already in full swing in Europe and the USA.
Japanese candle patterns show how the price of the chosen asset changed over a certain period. As mentioned in the rice analogy, this is a visual representation of the first and last price and their upper and lower limits for a certain period.
The candle has a very simple structure - the body and the shadow. A body shows the distance covered by the price of the asset from the opening to the closing of the period, that is, it is the price of the first and the last trade. The shadows show the maximum and minimum values of the price during this period.
On the charts, a rising candle is most often colored green. A red doji candle means that the candle is falling. In some variations, green corresponds to black and red to white. However, if you have a trading terminal or a trading platform, you can change these colors as you see fit.
What doji candlesticks show
It's time to explain what a Doji candlestick means. This is a candlestick model, which indicates the neutrality of the stock. Market neutrality is a situation where buyers and sellers balance each other out, resulting in no price movement during a particular trading session. The appearance of Doji candlestick patterns means that the forces of buyers and sellers are equal, and at this time the market was in a state of uncertainty.
Recall that the bulls are players in the stock market, whose main goal is to make money on the growth of assets. Bears are the opposite and make their main profit on the falling market.
How can we explain such behavior in the market? It is quite simple. For example, the market has no big players, which leads it to a certain balance. It is in such cases, on the trading charts, which are studied by adherents of technical analysis, there are Doji candles. This pattern indicates that the market will soon move in one direction or another. However, there are also cases where a Doji candle indicates not the reversal of the trend, but its continuation.
We will explain later how a trader can learn to determine which direction the market will move in when we proceed to the analysis of each of these patterns. For now, let me remind you that those who are not yet ready for independent trading, can use the strategy of Copy Trading - the ability to copy trades of famous traders. So you will not only make the same profit as they did, but you will also understand what a Doji candlestick means if the selected trader based his strategy on Doji candlesticks.
What does Doji mean? To understand this, we first have to answer another question - what does Doji mean in Japanese? Doji in Japanese means mistake or error, which is why this name was given to a certain type of candlestick pattern, to signify that it is a mistake that traders did not intend to make. This is the essence of trading, because traders always hope that the markets will move up or down, but not stay at one level.
A Doji candlestick always has a very small body. In some cases, the body is simply a horizontal line.
- Doji shadows are a bit more complicated. They are subject to the general laws of Japanese candlestick shadows.
- Symmetrical shadows mean uncertainty and the same desire of buyers and sellers to beat the market.
- Short shadows mean a narrow range of price fluctuations during the period and a kind of purposefulness of traders to maintain balance.
The difference between the lengths of the shadows means an attempt to pull the market to the side with which the shadow is longer.
For example, a "bullish Doji candle" indicates a bullish trend reversal. If this pattern appears on the chart, the price usually begins to rise after the fall. The same is true for the "bearish Doji candle", which indicates a bearish trend, or a post-breakdown in prices. If you know a bit about technical analysis and can read a chart, you will be able to tell if a Doji is bullish or bearish now.
Advantages of Doji candles
Informative
The main advantage of Doji candlesticks over other graphical analysis methods is the most detailed representation of the market situation. The line chart shows only price levels, bar chart - price levels, as well as opening and closing points. In contrast, the candlestick chart model also shows the positions of buyers and sellers.
Relevance
In contrast to the Point and Figure chart, which is not tied to a time interval, the Doji candlestick chart allows traders to notice every change in the market by any selected time interval.
Clarity
The color-coding of various indicators makes the candlestick chart more visual than other types of charts. Therefore, the Doji candlestick indicator can be recommended to novice traders.
Effectiveness
When combined with other methods of technical analysis, such as trend lines, moving averages, and oscillators, Japanese candlesticks give traders a complete picture of the market situation. The experience of many generations of investors allows us to claim that this method of graphical analysis is the most effective. Doji can also be used in crypto automation when the trading robot finds a pattern defined for a particular Doji on the chart and makes a decision based on this.
Types of Doji Candles
There are different types of Doji candlesticks, each indicating a different market behavior. Let's consider each of them in detail.
Neutral Doji
The Neutral Doji, sometimes referred to as the Doji star candlestick, states that an asset's starting and closing prices are equal. This is the fundamental idea behind this kind of candlestick. Yet, both the wicks above and below in this pattern have the same length. This suggests that the price change was the same on both sides of the starting and closing prices. Because neither the "bulls" nor the "bears" had a distinct advantage over one another during this trading session, most of the trades compensated one another. This indicates that both parties are unsure.
Long-legged Doji
The Long-legged Doji is very similar to the Neutral Doji, but with a long wick on either side of the opening and closing price. This pattern suggests quite a bit of market uncertainty, as the price has been going down and up quite a bit within a period. But after such an extensive movement and a wide range of prices, the result was almost the same level as the opening price. Long-legged Doji candlestick means that supply and demand in the market are currently approaching balance and that a trend reversal may occur in the future.
Gravestone Doji
This pattern is formed by a candle that has only the upper shadow. This indicates that the price tried to move higher but failed to do so and closed at a price equal to or slightly different from the opening price. Also, such a candle should have virtually nobody. The gravestone usually indicates that the buyers are losing power because they can no longer drive the price up and the sellers are in control. In most cases, the pattern is a reversal Doji candlestick, which can appear at the end of an uptrend.
Dragonfly Doji
Another Doji reversal pattern is an inverted version of the Tombstone Doji. The Dragonfly Doji candle has a long lower shadow, no or very small body, and no upper shadow. Thus, the opening and closing prices of the candle are the same or almost the same. Doji dragonfly is formed at the end of a downtrend and in most cases is taken as a signal of a possible upward price reversal.
Doji of four prices
This pattern is extremely rare on the chart and represents a straight line - only the body without shadows. The pattern is formed when all 4 prices are the same- open, close, low, and high. This happens either on very low-liquid assets or when volumes drop on the market, for example, during holidays or after the trading sessions are closed.
How to trade with Doji Candles
The classic rules for trading Doji candlesticks were developed decades ago, but they remain effective today. For practical application of these patterns, it is important to learn the basic features of working with them:
- Doji is a signal to open an order only if formed near a possible reversal upwards (Dragonfly) or a possible fall (Gravestone). Other types of Doji are very unlikely to predict a change in market movement.
- Doji should be considered as a trading signal only if there is a clear trend - for example, the bodies of 2-3 preceding candlesticks are at least 10-15 points. If this condition is not met, you should wait some more time for a clearer chart.
- The preceding Doji candles should be directed in the direction of the current trend.
When forming a long-legged Doji, before opening an order, it is important to wait for the completion of the formation of the next candle, which must necessarily be directed in the direction of the correction.
Doji candlesticks, when interpreted correctly according to these recommendations, provide 90% stable and accurate signals for opening trade orders. Knowing how to read them can make trading much more successful and reduce the risk of losing deals. Traders in Japan believe that candlestick analysis, including Doji candlesticks, is a valuable signal for actions aimed at maintaining a deposit or increasing it. Those who know how to analyze Doji will always be able to make money using these signals.
If you want to earn a big profit in trading, always use several instruments for technical analysis, combining them with Doji candlesticks. That way you can achieve much more and succeed in trading.
Why do people use Doji?
The main principle of technical analysis is that all the necessary information is encoded in the price and its dynamics. However, another important law of analysis tells us that past performance does not guarantee future results. There is little association between the history and the future of any given stock or financial asset.
Nevertheless, there is a way to extrapolate the existing data and find good prospects for both long-term and short-term investments. The idea behind Doji is to filter out the noise generated by excess market activity. A typical candlestick shows too much data trying to incorporate lows, highs, averages, and more in a single point of interest.
Doji candles simply reduce the amount of information to help traders identify strong probabilities for optimal trades by showing only relevant information. While this approach was not popularized as much as traditional line graphs and candlestick charts, it is still a valid way to process market information to form sound trading decisions.
A doji is essentially a point with only two sets of data: the closing and opening prices. Instead of incorporating other information, it boils down the whole spectrum of information to a very easy-to-interpret dot on the chart.
Should you focus on finding doji?
Many experienced traders try to incorporate as many tricks as possible in their trading systems. Doji is a good orienting point on a chart that can help you identify reversals. It can be another way to confirm a prognosis that technical indicators made.
Imagine a scenario where you have a strong indication that there will be a reversal of an upward trend:
- Three moving averages are crossing creating a point where the price may be changing the course and the trend is weakening.
- Your RSI is at 70 suggesting that the asset is overbought and should start going in the opposite direction for a price correction.
- You notice that there is a doji candlestick appearing and that the market seems to be close to finding an equilibrium for a time.
These three signals combined are a high-probability signal that there is at least a price retracement period when the asset is supposed to go down. While it won’t be a 100% correct prediction, there is a higher likelihood of it happening than when there is only one signal showing this particular forecast.
By incorporating doji-seeking patterns in your trading system, you will have an additional signal to rely upon when trying to identify a good moment to enter the market. Whether you need to use it as a sole predictor of future prices is a completely different question. Doji may form due to the indecisiveness of traders to generate a consensus in the market about the direction of the price.
They also appear when a market is waiting for a calendar event that may change the whole situation in the crypto industry and cause volatility. Doji alone does not predict anything in particular with a high degree of confidence. They are just natural occurrences in financial markets that can be interpreted as signals when other indicators suggest similar outcomes.
Tips for using Doji
- You may notice that some doji have longer wicks or tails indicating that there is a big difference between an entry point and a stop-loss location which is a high-risk scenario. You may want to avoid such trades altogether or be even more conservative with stop losses creating a high-risk situation.
- Doji appears frequently and using them in isolation is not the wisest strategy for any analyst. You should focus on trying to interpret them correctly using the context provided by the chart itself and the indicators that you use to analyze the market.
- Doji-based trades are hard to estimate correctly and may need additional contemplation to predict potential returns. Time spent on calculations can nullify any profits that you can gain due to a late market entry.
- In cryptocurrency trading, the formation of a doji candle may indicate that most investors are hesitant about the asset and do not want to contribute to price fluctuations. It is best to avoid trading altogether if you believe that the market is preparing for a move that you cannot predict.
- Do not rely on Doji to show you the moment to enter the market. It is a complementary analytical tool and a good little detail to notice and consider, but it is not the best predictor of any price action and should not be taken as such.
The main takeaway
Doji is an excellent phenomenon to learn and study. All newcomers to the cryptocurrency trading world should know about them and how to interpret them in different situations. However, it is still just an interesting tool and a weak signal. You should think of them as something more.
Understand why they occur and use them to confirm your guesses about the market dynamic, but don’t base your judgment on this highly unreliable analytical method.