All About Doji Candles in Forex
Video Transcription: Different Types of Doji Candles – How to Trade Them
Hello guys. We continue our trading academy on top rated forex brokers, and we’ll cover a subject that is full of controversy, namely a Doji candle. It is only one candle, so we talk about the Japanese approach to Technical analysis as part of the Japanese candlestick techniques.
(0.22) And that candle is full of mystery. (clicks on text). Let me spell if for you so that you know what it is. It’s a Doji candle, and it’s very famous in technical analysis. Now the problem with a Doji candle, is that while being a single candle, it does have a very important contribution to both reversal patterns and continuation patterns.
(0.52) And most of all, it shows uncertainty (he types it). Let’s put here, that it’s both a reversal pattern, and a continuation one. Therefore, you don’t really know how to trade a Doji continuation pattern (he types it) unless you fully understand the concept.
(1.27) Now, a Doji candle looks like this. Let’s build it here. So, we have the body of the candle which is almost invisible, and then you have the shadow of a candle (creates short line) which typically looks like this. But it is of course in a different colour depending on the candle. e.g. Bullishness or bearishness
(1.54) This is a Doji candle. What does it look like? It looks like a cross. Now, the problem with it, is that the Forex market changed in time. The broker’s executions today with the electronic communication network, with VCN and with the STP (straight through processing), it is very difficult for a daily or weekly candle to form a Doji candle like when it was formed many years ago.
(2.33) Why? Because now we have a quotation on any currency pair, take a look here at the euro-US dollar that has a value of 1.17331 or 2 so five digits that follow after the one. Therefore that means it is very difficult at the start of a trading day, to have a quotation like it is here, 1.17347 and then right at the end, which is 24 hours later to again have 1.17347. It is unlikely.
(3.07) Therefore in today’s world, you’ve got to give the Doji a bit of room. Let me show you what this means. This is the weekly chart on the euro-US dollar. Let’s zoom in, and this higher trend here (cursor at the bottom of screen) started in the summer, and the Euro US dollar went from 103 something in Spring actually, all the way up to 1.24 for a full 2000 Pips on its trade move up.
(3.45) Remember that the Doji shows continuation or reversal patterns. So, during these trips, how many candles do we have here? let’s count these candles
(3.55) So from here at the bottom and all the way to here, we have 35 weeks. During those 35 weeks, the euro/ US dollar moved to the upside. What candle here shows or resembles a Doji one? Let’s start from here. (moves cursor to bottom) This isn’t a Doji here, because the body is too big.
(4.20) Let’s try to find out where the OHLC one is, (searches and finds it) so that we can see the values. So, on this candle here, we have what? Let’s look at the opening price 10523, and the close is 10529 for six Pips, which it is not enough for a Doji.
(4.49) So which of these look like a Doji candle? (scrolls saying not here, not here) but if we go to this one here, this is a very nice Doji. Now let’s look at the opening price, 1.12015 and let’s look at the closing price 1.12039, so we’re talking about 2.5 pips, and then we check the time frame, which is the weekly time frame.
(5.13) So in the matter of a week or five trading days, we had two point something Pips difference on the Euro-US dollar pair. This qualifies it for a Doji. But remember what a Doji means or looks like. Let’s zoom out. There is uncertainty, which may mean consolidation, a continuation pattern or a reversal pattern.
(5.36) In the case of this Doji here, we don’t know which type of pattern it is. Why? Because it forms in the middle of this consolidation pattern, and it can be both a reversal or a continuation one. What should we do as forex Traders? it is very simple. We take a horizontal line.
(5.57) And we mark the top of this Doji candle like this, and for the very next week, it can be a reversal, right. We can only go long and buy if the price comes and breaks those highs, which is a good enough opportunity for us to go long, because the Doji showed a continuation pattern.
(6.19) Until then there was nothing. But at this very moment price wise, this candle, this green Doji. The market opened here, then moved low for the whole week, only to reverse and form what? A second doji candle.
(6.36) So two Doji candles or two weekly candles that show hesitation, formed on the euro-US dollar weekly chart, but this is a so-called dragonfly Doji.
(6.54) This is a bullish candle. This one here is a Dragonfly Doji. So we had one normal Doji that shows consolidation, that shows hesitation, and shows uncertainty for the future price and traders do not know if this is bullish or bearish. Then the next week forms a dragonfly doji which we know is Bullish.
(7.23) Here after the Dragonfly, it is dangerous to go long, all we need to do is wait for the highs, and to place a pending buy-stop order 1294 and when the market comes the 1294, simply, we go long, and here we see the trend resumed and move high.
(7.44) This is how to trade the Doji. Try to avoid using the daily chart, because there are many brokers who offer GMT prices and when they do offer GMT prices for the Sunday candle, you will only have two hours where the price doesn’t evolve much, and therefore you will have the impression on the daily chart you will see only Doji candles all over the place.
(8.07) So look on the 4 hour chart, or a weekly or monthly chart. It will take a bit of interpretation between the bid and the ask price. But the power of a Doji candle here (shows on screen), this example here sums it up well.
(8.25) Let’s move on with how to trade a trend. Everyone knows that a trend is your friend and we will see how to interpret a trend.. Goodbye
In the previous article dedicated to Japanese Candlestick techniques, we looked at one of the most powerful reversal patterns, the hammer/hanging man. A hammer was defined as being a candle that has a very long shadow and a small body. Moving forward, still on the patterns that have only one candle in their componence, the doji is the most enigmatic pattern to be found under the Japanese Candlestick techniques. The reason for this is that, on the one hand, this is not always a reversal pattern, and on the other hand, there are multiple types of doji candle that can appear at any one moment in time. By definition, a doji candle represents a candle where the opening and closing prices are the same. In other words, there is no body to be seen in the candle, but only shadows and a line given by the same opening and closing prices. The image below depicts what the standard type of a doji candle looks like. Such a candle is a distinct trend-change signal, especially during rallies, whether bullish or bearish ones. However, as you’ll find out below, doji candles are also considered to be continuation patterns when future price action is not confirming the doji candle. The real interpretation of a doji candle should therefore be a candle that is showing hesitation; that shows that both bulls and bears are fighting at that current level, and the market is in a state of uncertainty. The ideal doji candle will have the same opening and closing prices, but because we’re talking about the Forex market here, this is difficult to find. The reason for this is that lately the Forex market technology has improved, and now brokers are offering five-digit accounts when it comes to quoting a currency pair. Because of that, it is rare, if not impossible, to find a candle that opens and closes at exactly the same level. This is particularly true in the case of longer timeframes, such as weekly and monthly ones. A little flexibility is therefore needed, but nevertheless, the opening and closing prices of a doji candle should tend towards equality.
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Types of Doji Candles
Even though there are multiple types of doji candle that can be identified, they can be classified into two categories: doji candles that act as continuation patterns, and doji candles that act as reversal patterns. In both cases, it is vital to keep in mind that this is the overall tendency, not a rule of thumb. Having said that, here are the specific things to look for when trading a doji candle that belongs to one of the two categories mentioned above.
Doji Candles as Reversal Patterns
Like other candle groups that form the basis of Japanese Candlestick techniques, doji candles are valued for their ability to call a market top or a bottom. This is especially true when the doji candle follows a big green candle (if a strong bullish trend formed prior to the doji candle) or a big red one (if the previous trend was a bearish one).
The chart above is the AUD/USD 4-hour timeframe, and shows a doji candle forming after a strong bearish trend. Moreover, the doji candle follows a strong bearish candle, or a red one, and this is all a trader needs for a reversal pattern. Note the way the doji candle looks! The opening and closing prices are not the same, as a little bit of flexibility is important, because this is the Forex market.
Doji Candles as Reversal Patterns
A doji candle does not only act as a reversal pattern, though, as, like mentioned a bit earlier, there is a certain degree of uncertainty when such a candle appears. In other words, the market is hesitating. It is not mandatory in a bullish trend for the market to decline after a doji candle appears, just as it is not mandatory in a bearish trend for the doji to signal a reversal. After all, the real value of a doji candle is the fact that it shows that the trend may be in the process of changing.
The image above shows no less than two consecutive doji candles that in this case act as a continuation pattern, as after the consolidation ended, the price simply exploded to the upside, thus resuming the previous trend. This is what a doji as a continuation pattern looks like. However, if we are to respect everything that has been mentioned in this article, it is important to look at the candle prior to the doji candle. It was pointed out earlier in this article that, for a doji candle to be a reversal one, it needs to follow a strong candle from the previous bullish or bearish trend. In the example above, the candle prior to the doji one was supposed to be a strong green one, and it is not. This means that it is not a reversal that the doji is signalling, but more likely a continuation pattern. As such, staying with the direction of the previous trend is indicated, as the doji calls for this kind of trading decision to be made. Needless to say, after one more candle that shows the market consolidating, the price resumes the previous trend. In this way, the doji candle was useful in spotting a fake reversal and offering the possibility to add to a previous long trade. So powerful are these candles that they sometimes offer great opportunities to end up on the right side of the market.
The two situations presented in this article are the main ones worth considering when trading a doji. These candles are subdivided into further subcategories such as long-legged doji, southern and northern doji, gravestone and dragonfly doji, etc. However, they represent variations on the same theme: A doji candle can be either a continuation or a reversal pattern. With this in mind, traders have little room for error when it comes to making a trading decision after a doji candle appears.
Other educational materials
- Spot Reversal Patterns with a Hammer and a Hanging Man
- Trading 5th Wave Extensions
- Trading with the Cloud – Use Ichimoku Cloud to Spot Reversals
- Forex Market Terminology
- Profit from Forex Trading Using Different Trading Styles
- How to Set Up an Expert Advisor
Recommended further readings
- “Finding trading patterns in stock market data.” Nesbitt, Keith V., and Stephen Barrass. IEEE Computer Graphics and Applications 24, no. 5 (2004): 45-55.
- “Stars, crows, and doji: The use of candlesticks in stock selection.” Horton, Marshall J. The Quarterly Review of Economics and Finance 49, no. 2 (2009): 283-294.