Doji candlestick forms some important patterns. Memorizing the name of the candlesticks and their patterns is not that important. We just need to be able to recognize the signals. Sometimes you can not find any name for a candlestick pattern, but you know that a good signal is formed.
There is an important Doji pattern which is called Doji Star. There are two kinds of Doji Star: Evening Doji Star and Morning Doji Star.
A Doji Star forms at the top of an uptrend or bottom of a downtrend. A
gap between the Doji Star and its previous candlestick is effective on the strength of the signal that the Doji Star candlestick forms.
Evening Doji Star
When a Doji Star forms at the top of an uptrend it is called Evening Doji Star and when it forms at the bottom of a downtrend it is called Morning Doji Star.
Let’s look at the 2005.09.05 candlestick on EUR/USD daily chart again. As this candlestick is formed at the top of an uptrend or we’d better to say at the end of of bullish movement, it is an Evening Doji Star.
Why is it called evening…? It goes back to the time that stock traders could buy long only and they could not sell short. So they loved to see uptrends or bullish movements, but when a reversal signal formed at the end of an uptrend or bullish movement, they got upset, because it meant that they had to wait maybe for a long time to have another bullish movement to go long and make some money. So having a reversal signal on a bull market was like the end of the day which is the end of daily business and making money. That is why a Doji Star on a bull market is called Evening Doji Star.
As you see on the below chart, there is a gap between the Doji Star and its previous candlestick (#1). This gap makes the Doji Star signal stronger. We will talk about the meaning of Doji candlesticks and the way we can trade using the signals they form. Candlestick #2 is a confirmation. To trade using a Doji candlestick signal, we should have a confirmation which is usually the next candlestick. We will explain about it later in this article.
Morning Doji Star
A Doji Star that forms at the bottom of a bear market is called Morning Doji Star. The 2006.09.11 candlestick on
GBP-USD daily chart is a Morning Doji Star. As you see this candlestick has a small body, because its close price is a little higher than its open price, but it is still a Doji. Look at the next candlestick (#1) which is a big bullish candlestick. GBP-USD went up for over 320
pips after the candlestick #1 was closed.
What Does Doji Mean?
Doji candlestick forms when market is indecisive. Imagine a Doji candlestick on a weekly chart. At the beginning of the week that the candlestick opens, it goes up or down throughout the week days and forms its upper and lower shadows, but when the week is about to be over, the price gets closer to the market price at the beginning of the week, and finally our candlestick closes with the same or almost the same market price the market opened at the beginning of the week. It means the market has not been able to take any special direction during the week and after a lot of struggle, it went back to where it was at the beginning of the week. This indecision happens while the market has been going up or down at least for a few candlesticks (weeks). So the market is not sure if it should keep on following the same direction, or it should reverse and take the opposite direction.
Why does this happen?
Markets move and prices go up and down because of two things: supply and demand or selling and buying. When there is more buying than selling, market is bullish and price goes up and visa versa (bearish market). So price goes up when most people decide to buy and it goes down when most people decide to sell. When the price goes up and down for a period of time, but then goes back to the level that it was at the beginning of the period, it means buyers and sellers or bulls and bears have the same power and none of them is stronger. When this happens at the end of a bull market that there were stronger buying activity, it means buyers (bulls) do not want to buy anymore. They stop buying and at the same time some of them start selling. So the price will not go up anymore and it moves around the same level for a while. It is when a Doji candlestick forms. Now, if more buyers decide to sell, the price will go down and a reversal forms. It is when the next candlestick after the Doji will form. If its direction is against the direction of the market before the Doji candlestick formation, it means market wants to change its direction. If buyers decide to keep on buying again, the price will continue to go up like it was used to be before the Doji candlestick formation.
A Doji candlestick is a reversal signal, but it needs confirmation. Its confirmation is the next candlestick, or sometimes one of the next a few or few candlesticks. If the next candlestick follows the direction that the market had before the Doji formation, it means no reversing will happen and the Doji should be ignored. As you see on the below chart, the 2004.11.26 candlestick closed as a Doji Star on GBP-USD daily chart, but the next candlestick (#1) that formed after the Doji Star was still a bullish candlestick and the candlestick after that (#2) continued the previous direction strongly.
A reversal signal will be formed, if the next candlestick forms against the market direction. Like the 2006.09.11 candlestick on GBP-USD daily chart, 2005.09.05 candlestick on EUR-USD daily chart and 2009.07.22 ; 20:00 candlestick on EUR-USD one hour chart that you already saw above. To learn more about the
confirmation candlestick, please read this article:
The Importance of the Confirmation Candlestick
Therefore, Doji is not a reversal signal by itself. To form a reversal signal, Doji needs to be followed by a candlestick that its direction is against the direction that the market had before the formation of Doji candlestick.
How to Trade Using Doji Candlestick and Bollinger Bands®
Doji candlestick signals and patterns are sometimes tricky. If we add another tool to our charts, we can avoid many of the false signals and nothing is better than
Bollinger Bands to help us do that. As you can see, we already have the Bollinger Bands on all of the above examples.
The secret is in the Bollinger Bands breakout. The Doji candlestick and preferably its previous and next (confirmation) candlesticks should break out of the Bollinger Upper Band, in case of Evening Doji Star, or the Bollinger Lower Band, in case of Morning Doji Star. We will talk about the
Bollinger Middle Band also and the way you have to deal with it. Let’s take a look at some examples.
On the below chart, a
hammer candlestick is formed completely out of the Bollinger Lower Band. We are talking about Doji, but on the below example, the reversal signal has become stronger by the
hammer. A Doji is formed after the hammer (2007.06.14 candlestick on EUR-USD daily chart). As you see the lower shadow of Doji has broken out of the Bollinger Lower Band. However, this breakout is not strong enough and if there was only the Doji, we should have ignored the signal, but as I said, that hammer which is completely formed out of the Bollinger Middle Band, has strengthen the signal. Then a strong confirmation candlestick formed after the Doji and as you see EUR-USD went up for hundreds of pips after the confirmation candlestick. The long position should be taken after the confirmation candlestick close. Stop loss should be placed several pips below the lower shadow of Doji, or in this case, below the lower shadow of hammer. The first target should be the same size as the stop loss size at least. You can collect a portion of your profit at the first target and move your stop loss to breakeven. Your second target can be twice of the stop loss size at least.
I show you some examples from the signals that worked and then will show you some false signals and the way you can avoid them.
This is a Doji formed on 2006.03.03 on EUR-USD daily chart. As you see its lower shadow and also its small body are formed out of the Bollinger Upper Band. 2006.03.03 Doji was a Friday candlestick. The next candlestick opened with a
gap up and went up strongly, but then it went down and closed below the Doji close price and also the Bollinger Upper Band. The upper shadow of the confirmation candlestick and about 50% of its body is out of the Bollinger Upper Band. This is a strong signal. We could go short after the confirmation candlestick close and our stop loss could be placed few pips above the confirmation candlestick upper shadow. Our second target could be easily triggered the next day.
But the question is why it went down only for one candlestick after the confirmation. The reason is that market was
oversold, because it has been going down for a long time. The 2006.02.28 candlestick had already formed a strong bullish signal. The 2006.03.02 is such a strong bullish candlestick. The market had already changed its direction. Taking a short position right after such a strong bullish movement is not a good idea.
This is the same 2005.09.05 Doji candlestick on EUR-USD daily chart. As you see the candlestick before the 2005.09.05 Doji and also the Doji candlestick itself have broken out of the Bollinger Upper Band. The Doji breakout is not strong enough, however, the previous candlestick breakout is strong. But this is not enough to go short. The confirmation candlestick encourages you to take a short position and put your stop loss few pips above the Doji or its previous candlestick upper shadow. What if you are wrong? Never mind! Your stop loss is there.
Why did this signal take the price down strongly, whereas in the previous example it didn’t work the way it was expected? I explained about the previous example. The market was oversold already and some bullish signals were formed. But Doji Star sell signal worked with the below example, because the market was
overbought and another sell signal was already formed 16 days ago on 2005.08.12. That signal tells us that bears are getting stronger and they are able to take the price down.
The below
screenshot shows three signals. The first one is the signal that has to be ignored. Although the Doji, its previous and next candlesticks have strong breakouts, the confirmation candlestick is strongly bullish. So you always have to wait for the confirmation candlestick to close.
The second signal is a good signal, but I would ignore it. I do not take the first reversal signal that forms at the top of a bull market or bottom of a bear market. The reason is that usually markets follow the same direction after the first reversal signal.
The third signal is an ideal reversal signal. It is an Evening Doji Star formed on 2002.07.19 on EUR-USD daily chart. Its previous candlestick doesn’t have anything to say, but two candlesticks before formed another kind of candlestick patterns called
Dark Cloud Cover. So after the formation of the confirmation candlestick, we could trust the signal to go short and place our stop loss above the Doji upper shadow.
It is time to ask me whether I trade these signals or not. I trade the strong candlestick signals with strong Bollinger Band breakout. Both the candlestick pattern and the Bollinger Band breakout have to be strong.
Now let’s see some false signals or some signals that didn’t work the way it was expected. The yellow zone on the below screenshot covers the
daily candlesticks from 2007.02.15 to 2007.02.22. These candlesticks look like reversal signals. The first candlestick (2007.02.15), formed completely out of the Bollinger Upper Band. This is what a reversal signal has to have. The next candlestick formed as a Doji. The next candlestick that had to be the confirmation candlestick, formed as another Doji. So we do not have any reversal signal so far. The 2007.02.20 candlestick (the red arrow) might be able to make us go short. Although the next two candlesticks could hit our first target, but this was not a good signal. Look at the green arrows and the strong downward movement we had before them. We had a downtrend that was reversed. The signals we have in the yellow zone are among the signals that we have to ignore (I already talked about the signals that I ignore. This is another example.)
This is another example (below chart) that a Doji signal has to be ignored. On 2005.11.07 a Doji formed completely out of the Bollinger Lower Band, on EUR-USD daily chart. Almost half of its previous candlestick also formed out of the Bollinger Lower Band. However, it would have triggered the stop loss if we would have gone long. The next candlestick (confirmation), didn’t confirm a reversal signal, but even if it did, it was not a good idea to go long after two huge bearish candlesticks (the red arrows).
In general, to have a reversal signal, we need something more than a Doji, a confirmation candlestick, as well as Bollinger Band Breakout. We have to know where the reversal signal is formed. If it is at the middle of a strong bull or bear market, it has to be ignored. The first reversal signal that forms at the top of a strong and fresh bull market or at the bottom of a strong and fresh bear market is not a reversal signal. In fact, it is a continuation signal.
What About the Bollinger Middle Band?
Bollinger Middle Band is a tricky area. You should avoid taking any position when the price is moving around this area, unless there are enough evidences that help you guess the next market direction.
The Doji on the below chart is not a trading signal. It is just a candlestick that reflects the market indecision. However, an experienced trader knows that the market would break above the Bollinger Middle Band sooner or later, but as it is not clear when, you can not take any position until it really breaks above the Bollinger Middle Band.
Let’s have some exercise:
What position would you take after this Doji and its next candlestick?
It is not easy to guess. If you say it goes up because of the long and big bullish candlestick that formed below the Bollinger Middle Band, I would say what about the several bearish candles we have before it. It may go down because it has been going down before, it broke down the Bollinger Middle Band and it is just retesting now. So it will go down. Both ideas can be correct.
It went up and broke above the Bollinger Middle Band, but then went down to retest the Bollinger Middle Band and formed a Doji there. The confirmation candlestick also is a strong bearish candle. This Doji and its confirmation have formed a good reversal signal. Would you go short?
I would not because both of these candlesticks are closed above the Bollinger Middle Band. Let’s see what happened then:
The below chart shows the whole story. One Doji below the Bollinger Middle Band and another one above it. Both f them were retesting candlesticks. It is not impossible to guess the market direction when it is around the Bollinger Middle Band, but it needs more experience.
These two Doji candlesticks are formed on EUR-JPY daily chart, 2009.05.20 and 2009.05.26.
Would you go short here?
I would not, because…
1. The uptrend is strong; 2. the Doji candlestick and its Bollinger Band breakout is not strong enough; 3. the confirmation candlestick has a
long lower shadow which means there are still a lot of bullish pressure. Read about the importance of the lower shadow in an uptrend:
Candlesticks Lower Shadows on an Uptrend
Another test:
It looks like a relatively good signal to go short, but it goes down after hitting our stop loss. The Bollinger Upper Band breakout was not strong enough and also it was the first sell signal after a strong bullish movement. So we should have ignored it.
Source : Fxkeys.com
