Doji Candlestick Pattern

Explanation of Doji Candlestick Pattern

The Doji candlestick pattern is a signal in technical analysis that reflects market indecision. This pattern forms when the opening and closing prices are nearly identical, resulting in a small or non-existent body. The Doji is typically characterized by long upper and lower wicks, signifying that price moved both higher and lower during the session but closed near its opening price. This pattern often signals a potential reversal or pause in the prevailing trend, making it important to monitor subsequent candles for confirmation.

Illustration of Doji Candlestick Pattern

The Doji candlestick pattern is illustrated below:

Key Pattern Features of the Doji Candlestick Pattern

• Very small or non-existent real body (open and close prices are nearly equal).
• Long upper and lower shadows indicate significant price movement in both directions.
• Signals indecision or equilibrium between buying and selling forces.
• Often seen at potential market tops or bottoms, indicating possible trend reversal.
• Requires confirmation from subsequent price action.

Trading Psychology of Doji Candlestick Pattern

The Doji pattern represents a moment of indecision in the market where neither buyers nor sellers gain control. It reflects a balance of power between the two forces, suggesting that the prevailing trend is losing momentum. Buyers are no longer confident enough to push prices higher, and sellers are equally reluctant to drive prices lower. This often leads traders to expect a reversal, though confirmation from the next few candlesticks is essential.
The pattern can lead to reversals because it shows that market participants are unsure about the current trend’s continuation. However, in some contexts, it may result in a continuation if the subsequent price action reasserts the trend.

Conventional Approach to Using Doji Candlestick Pattern

• Market Conditions: The Doji pattern is often associated with reversal signals in trending markets. In an uptrend, it may suggest that bullish momentum is weakening, while in a downtrend, it can imply that sellers are losing control. The pattern tends to perform better in trending markets when it appears after a strong price move. In sideways or consolidating markets, Dojis often highlight short-term indecision without providing a clear signal for future direction.
• Volatility Considerations: In low volatility environments, Dojis can effectively signal a potential reversal. However, in high volatility conditions, Dojis may appear more frequently due to large price swings, leading to more false signals. As such, additional technical analysis or confirmation is typically needed to make the Doji a reliable signal in such markets.

Risk Management Suggestions for Doji Candlestick Pattern

Systematic traders might consider placing stop-losses just below the low of the Doji in a bullish setup or just above the high in a bearish setup. This approach limits risk in case the market moves against the anticipated reversal. However, as with any pattern, backtesting these levels is essential before blindly following conventional wisdom to ensure their effectiveness.

Does the Doji Candlestick Pattern Actually Work?

The following analysis shows the average profit per trade from purchasing selected ETFs on the open after the doji pattern is formed assuming the trade is held for 5 trading days. The scenarios covered include:

• Primary Bull (Bear) Market: Close above (below) the 200 day simple moving average
• Short Term Strength (Weakness): Close above (below) the 20 bar simple moving average
• Low (High) Volatility: 20 bar Average True Range/Close is below (above) the 200 day moving average of the same

The purpose of this is to determine quickly whether the pattern holds any edge as an entry for these ETF’s. Obviously there are many ways to test this and I would suggest you test the pattern in your own backtesting.

All numbers presented represent average percent gain over the 5 days following the signal with no other exits. Darker green areas represent larger positive edge, darker red indicates potential areas edge on the short side.

Pattern Failure Conditions for Doji Candlestick Pattern

The Doji pattern may fail when:

• It appears frequently in high volatility conditions, generating false signals.
• It does not receive confirmation from the following candlestick. For example, if a Doji appears in a downtrend but is followed by another bearish candlestick, it may signal continuation instead of reversal.
• The market is driven by external events such as news releases, overriding typical technical patterns.

Systematic Trading Application for Doji Candlestick Pattern

A systematic trader could use the Doji pattern as a trigger for entry or exit in a trading system. For example:

• Entry Rule: Enter a long trade when a Doji appears after a downtrend and is followed by a bullish confirmation candle (e.g., a candle with a higher close).
• Exit Rule: Exit the position when the price closes below the low of the Doji’s confirmation candle or when a predetermined profit target is reached.

As always, backtesting is crucial. Not all candlestick patterns work well in all markets or conditions, so it’s important to verify their reliability in your chosen market before using them in a live trading environment.

Amibroker Code for Doji Candlestick Pattern

// Amibroker AFL code to identify the Doji candlestick pattern
doji = abs(O – C) < ((H – L) * 0.1);

Links to articles about other Candlestick Patterns

1. Doji
2. Hammer
3. Inverted Hammer
4. Bullish Engulfing
5. Bearish Engulfing
6. Morning Star
7. Evening Star
8. Shooting Star
9. Hanging Man
10. Piercing Pattern
11. Dark Cloud Cover
12. Three White Soldiers
13. Three Black Crows
14. Dragonfly Doji
15. Gravestone Doji
16. Spinning Top
17. Marubozu
18. Tweezer Top
19. Tweezer Bottom
20. Bullish Harami 
21. Bearish Harami
22. Rising Three Methods
23. Falling Three Methods
24. Bullish Abandoned Baby 
25. Bearish Abandoned Baby 
26. Bullish Kicker 
27. Bearish Kicker
28. Three Inside Up
29. Three Inside Down
30. Upside Gap Two Crows
31. Mat Hold
32. Upside Tasuki Gap
33. Downside Tasuki Gap