Being able to identify and interpret candle charts is an important technical market skill for Forex traders to master. Candle shapes and patterns can give visual insight into what traders are thinking as well as provide critical levels of support and resistance. With this idea in mind we will focus on recognizing and trading one of the markets most prevalent candles, the doji.
What is a doji?
A doji candle is formed when price causes a candle to open and close at nearly the same price. Pictured above, you will see that doji candles visually will appear like a plus sign or a cross on your graph. The body of the candle should be very short, with wicks elongated to either side. These wicks symbolize the market volatility during the specified charting period. However, since price opened and closed at virtually the same price neither the bulls or bears appear to be in control of the market.
Since market momentum has stalled, the doji candle traditionally signifies market indecision. Traders can use this indecision as an opportunity to plan for an increase in momentum. Often traders choose to use support and resistance levels for fresh market breakouts or to identify areas where a broader trend may continue. Let's take a look at a practical trading example using the GBPUSD daily chart seen below.
(Created using FXCM's Marketscope 2.0 charts)
Uses in Trading
Once you are familiarized with identifying dojis, they can then actively applied to virtually any trading strategy. Since the candle itself does not give us much information regarding market direction, dojis are often used in conjunction with a trend lines or other support and resistance indicators. Above is an example of a doji, forming near a support line on the GBPUSD daily graph. Since price has been moving lower back to support prior to the creation of a doji, a potential change in direction would indicate a resumption of bullish strength.
An aggressive trader can look to enter into the market in the direction of the trend after the creation of a doji candle. Risk can be managed as well using this candle with stops being placed below the wick low which is now acting support for the pair. From here traders can then extrapolate a positive risk reward level of their choosing.
---Written by Walker England, Trading Instructor
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