Most of the ardent followers of chart patterns must have come across the term 'Doji' either on business news channels or Internet. Doji is a chart pattern which signifies indecision in the market. It is a candlestick in which opening and closing prices for the period under consideration are same. It is a major trend reversal signal especially at market tops or even at market bottoms.
Wikipedia describes Doji as, "The doji is a commonly found pattern in a candlestick chart of financially traded assets (stocks, bonds, futures, etc). It is characterized by being small in length -- meaning a small trading range -- with an opening and closing price that are equal."
It further interprets a Doji as, "The doji represents indecision in the market. A doji is not as significant if the market is not clearly trending, as non-trending markets are inherently indicative of indecision. If the doji forms in an uptrend or downtrend, this is normally seen as significant, as it is a signal that the buyers are losing conviction when formed in an uptrend and a signal that sellers are losing conviction if seen in a downtrend. Most traders will place greater significance on the doji when it forms in a market that is in overbought or oversold territory as noted by oscillators like relative strength index or MACD."
Doji: A Potent Top Reversal Indicator
It must be noted that a Doji is more potent towards its formation at the top of the rally or at the bottom of the downward correction, rather than in between the up or down journey of the markets. A Doji at the upper end of the rally is a sign of exhaustion of the power of the bulls to further pull the market higher. As soon as the bears get a sniff of this lack of conviction among bulls, the charge swaps hands from bulls to bears at least for some time to come.
Doji: To be Coupled with Confirmation
A Doji in itself is not a confirmation of the prevailing trend's reversal. It needs to be coupled and confirmed by the follow-up reversing move with in next few candlestick patterns. As such, a Doji at a market top could be a warning for the bulls to cover longs and remain neutral only to further initiate shorts once the bearish confirmation is received. A bearish confirmation is much needed before initiating any short position as a trend reversal could also mean change of trend to 'lateral' consolidation and not necessarily a complete reversal of trend.
Nifty & Doji
In the below given charts, we will see how a couple of Dojis stalled the market rally around Nifty 5300 level during first week of January 2010 which led markets to consolidate & further correct on witnessing one more doji around January 20, 2010.
Charts Courtesy: www.icharts.in
In the above Daily charts of Nifty, we see how the rally in the benchmark index, which was in an up trend since December 22 starting from Nifty 4950 level, got stalled by the emergence of 'twin' doji on January 05 and 06. The existence of Doji after the rally indicated exhaustion of the up trend. However, bulls were in no mood to completely give up just yet nor were bears in any mood to let bulls continue their charge. This ensured that the Nifty moved in a congestion band of 5200 to 5300 range. At least, we can say that the sudden emergence of Doji at higher levels ensured a trend 'Change' from bullish to lateral movement.
It was only after the existence of the third Doji on January 20, that the bears were able to take a complete charge of the situation in favour of a correction in the trend. A long bearish candlestick formed on the follow-up session of the Doji day (January 21) was enough confirmation evidence for the bears that the up trend is over at least for some time to come.
So, in effect, for a market which was powerfully in hands of bulls since quite some time needed 3 occurrences of Doji (read indecisive attempts) in order to turn the trend over head in favour of bears. The first two doji led to Trend 'Change' and the third was a final coup to start a Trend 'Reversal'. But the change was inevitable as doji at market tops indicated lack of certainty and vigour amongst bulls to carry market higher. Just have a look at the Resistance line as defined by the Doji formed on January 06, which proved to be a stiff market top ever since then.
Doji in the Midst of a Trend
Again, on January 28, we witnessed a Doji at the midst of a down trend. This doji indicated lack of vigour amongst bears to drag market further down at least for the time being. The doji was followed twin hammers on January 29 and February 01. The doji led the markets to consolidate for the next 5 sessions as can be seen from above charts. However, the doji which appeared in the midst of the downtrend was not so successful in reversing the trend as it was at the higher band of the market. This shows that Doji is highly effective and most potent at market tops than during the midst of the up or down trend.
So, it is very crucial to determine as to where the Doji occurs and during which stage of market. Doji in midst of the trend transition need not be as potent as at market top or bottom. At the same time, a Doji indication is best served when coupled with other confirmation evidences of trend change.
Variations of Doji
1) Gravestone Doji: Lows, Opening & Closing are Same.
2) Dragonfly Doji: Highs, Opening & Closing are Same.
3) Long-Legged Doji: Volatile Highs or Lows, but Same Closing and Opening.
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