What Is a Doji?
A doji—or more accurately, "dо̄ji"—is a name for a trading session in which a security has open and close levels that are virtually equal, as represented by a candle shape on a chart. Based on this shape, technical analysts attempt to make assumptions about price behavior. Doji candlesticks can look like a cross, inverted cross, or plus sign. Although rare, a doji candlestick generally signals a price reversal indication for analysts. Broadly, candlestick charts can reveal information about market trends, sentiment, momentum, and volatility. The patterns that form in the candlestick charts are signals of such market actions and reactions.
- Doji are used in technical analysis to identify securities price patterns.
- A doji names a trading session in which a security has an open and close that are virtually equal, which resembles a candlestick on a chart.
- The word doji comes from the Japanese phrase meaning "the same thing."
- A doji candlestick is a neutral indicator that provides little information. They are rare, so not reliable for spotting things like price reversals.
- Doji formations come in three major types: gravestone, long-legged, and dragonfly.
What Does a Doji Tell Investors?
In Japanese, "doji" (どうじ 同事) means "the same thing," a reference to the rarity of having the open and close price for a security be exactly the same. Depending on where the open/close line falls, a doji can be described as a gravestone, long-legged, or dragonfly, as shown below.
Technical analysts believe that all known information about the stock is reflected in the price, which is to say the price is efficient. Still, past price performance has nothing to do with future price performance, and the actual price of a stock may have nothing to with its real or intrinsic value. Therefore, technical analysts use tools to help sift through the noise to find the highest-probability trades.
One tool was developed by a Japanese rice trader named Honma from the town of Sakata in the 18th century, and it was introduced to the West in the 1990s by Steve Nison: the candlestick chart.
Every candlestick pattern has four sets of data that help to define its shape. Based on this shape, analysts are able to make assumptions about price behavior. Each candlestick is based on an open, high, low, and close. The time period or tick interval used does not matter. The filled or hollow bar created by the candlestick pattern is called the body. The lines that extend out of the body are called shadows. A stock that closes higher than its opening will have a hollow candlestick. If the stock closes lower, the body will have a filled candlestick. One of the most important candlestick formations is called the doji.
A doji, referring to both singular and plural forms, is created when the open and close for a stock are virtually the same. Doji tend to look like a cross or plus sign and have small or nonexistent bodies. From an auction theory perspective, doji represent indecision on the side of both buyers and sellers. Everyone is equally matched, so the price goes nowhere; buyers and sellers are in a standoff.
Some analysts interpret this as a sign of price reversal. However, it may also be a time when buyers or sellers are gaining momentum for continuing a trend. Doji are commonly seen in periods of consolidation and can help analysts identify potential price breakouts.
Using a Doji to Predict a Price Reversal
The following chart shows a gravestone doji in Cyanotech Corp.'s (CYAN) stock from February 2018 following a significant high-volume uptrend, which could indicate a bearish reversal over the near term following the breakout.
In this example, the gravestone doji could predict a further breakdown from the current levels to close the gap near the 50- or 200-day moving averages at $4.16 and $4.08, respectively.
Traders would also take a look at other technical indicators to confirm a potential breakdown, such as the relative strength index (RSI) or the moving average convergence divergence (MACD). Day traders may also put a stop-loss just above the upper shadow at around $5.10, in this case, although intermediate-term traders may place a higher stop-loss to avoid being limited out of the trade.
What Is the Difference Between a Doji and a Spinning Top?
Candlestick charts can be used to discern quite a bit of information about market trends, sentiment, momentum, and volatility. The patterns that form in the candlestick charts are signals of such market actions and reactions.
Doji and spinning top candles are commonly seen as part of larger patterns, such as the star formations by technical analysts. On their own, they both indicate neutrality in price.
Doji and spinning tops show that buying and selling pressures are, essentially, equal, but there are differences between the two and how technical analysts read them.
Spinning tops are quite similar to doji, but their bodies are larger, where the open and close are relatively close. A candle's body generally can represent up to 5% of the size of the entire candle's range in order to be classified as a doji. Any more than that, and it becomes a spinning top.
A spinning top also signals weakness in the current trend, but not necessarily a reversal. If either a doji or spinning top is spotted, look to other indicators such as Bollinger Bands to determine the context to decide if they are indicative of trend neutrality or reversal.
Limitations of a Doji
In isolation, a doji candlestick is a neutral indicator that provides little information. Moreover, a doji is not a common occurrence; therefore, it is not a reliable tool for spotting things like price reversals. When a reversal does occur, it isn't always reliable, either. There is no assurance the price will continue in the expected direction following the confirmation candle.
The size of the doji's tail or wick coupled with the size of the confirmation candle can sometimes mean the entry point for a trade is a long way from the stop-loss location. This means traders will need to find another location for the stop-loss, or they may need to forgo the trade because too large of a stop-loss may not justify the potential reward of the trade.
Estimating the potential reward of a doji-informed trade also can be difficult because candlestick patterns don't typically provide price targets. Other techniques, such as other candlestick patterns, indicators, or strategies are required to exit the trade, when and if profitable.
What Is a Dragonfly Doji Candle?
The dragonfly doji is a candlestick pattern stock traders analyze as a signal that a potential reversal in a security's price is about to occur. Depending on past price action, this reversal could be to the downside or the upside. The dragonfly doji forms when the stock's open, close, and high prices are equal. It's not a common occurrence, nor is it a reliable signal that a price reversal will soon happen. The dragonfly doji pattern also can be a sign of indecision in the marketplace. For this reason, traders will often combine it with other technical indicators before making trade decisions.
What Is a Gravestone Doji Candle?
A gravestone doji candle is a pattern that technical stock traders use as a signal that a stock price may soon undergo a bearish reversal. This pattern forms when the open, low, and closing prices of an asset are close to each other and have a long upper shadow. The shadow in a candlestick chart is the thin part showing the price action for the day as it differs from high to low prices. While traders will frequently use this doji as a signal to enter a short position or exit a long position, most traders will review other indicators before taking action on a trade.
What Is a Long-Legged Doji Candle?
The long-legged doji is a type of candlestick pattern that signals to traders a point of indecision about the future direction of a security's price. This doji has long upper and lower shadows and roughly the same opening and closing prices. In addition to signaling indecision, the long-legged doji can also indicate the beginning of a consolidation period where price action may soon break out to form a new trend. These doji can be a sign that sentiment is changing and that a trend reversal is on the horizon.
Is a Doji Bullish or Bearish?
A doji formation generally can be interpreted as a sign of indecision, meaning neither bulls nor bears can successfully take over. Of its variations, the dragonfly doji is seen as a bullish reversal pattern that occurs at the bottom of downtrends. The gravestone doji is read as a bearish reversal at the peak of uptrends.
How Can a Doji Be Used in Cryptocurrency Trading?
As with stocks and other securities, the formation of a doji candlestick pattern can signal investor indecision about a cryptocurrency asset.