Study of Doji Pattern
Doji is a single candle stick pattern that indicates indecisiveness among the investors. This name is given to candle with no body and having wicks on both side. The pattern can be either reversal signal or continuation of earlier trend. Lets see how it looks like:
What is the psychology behind formation of Doji?
The text book definition of Doji candle is that it is without body with wicks on both side. In real world, even a candle with very small body is considered as Doji. Lets understand the psychology behind the formation of the candle.
Without body: A candle without body means that there is no difference between opening price and closing price at end of the day. This indicates that neither bulls nor bears are in real control and this shows indecisiveness in the mind of trades. They both are fighting with one another but both fails at the end.
Upper Wick : Upper wick suggest thst the bulls have tried to take the stock price higher but fails due to the strong bearish sentiments at higher level. The bears push the stock price lower.
Lower Wick: Lower wick suggest that the bears have tried to take the stock price lower but fails due to the strong bullish sentiments at lowest level. The bull push the stock price higher.
Significance of Doji
These candles does not suggest any entry or exit point but if it emerges in strong uptrend or downtrend than it can either be a reversal signal or a continuation of previous trend. They have same significance as in Spinning top candle stick pattern. The important point to discuss here is that the color of candle does not make any difference. Lets understand its importance through technical charts:
1. Doji in Uptrend
- First example is of Marico with stock in an uptrend, stopping for a while on formation of Doji and resume uptrend again. Here Doji act as continuation pattern.
- Second example is of Hindalco with a stock is in an uptrend, Doji emerges on the chart and stock reverses its direction. Here Doji is acting as reversal signal.
2. Doji in Downtrend
- Third example is of Tata Motors with a stock is in downtrend, stock stops for a while on the back of Doji and resume downtrend. Here Doji acting as continuation pattern.
- Fourth example is of Infosys stocks that stops falling on Doji and reverses its direction to upward direction. Here Doji acting as reversal pattern.
How to use the pattern effectively?
Doji as discussed is a reversal or continuation pattern and can be used effectively in the following manner:
- If you have already bought a stock at lower price and stock is in uptrend, Doji patterns are really useful as trader can sell 50% of the stock at current market price. Remaining 50% will help him to ride with uptrend in case the stock keeps moving up. In case the stock reverses direction than he can sell remaining 50% and this will result him to book higher profits.
- This pattern can also be used to enter a stock which is already moving up as Doji is continuation pattern as well. Our suggestion is to put 50% of the decided amount and if stock begins to move up than put next 50%. This will result in lower buy average price for the trader as 50% invested at lower price. In case the stock start falling than the trader can book loss and good thing is that this will result in lesser loss at only 50% amount is invested.
- If you have already short the downward trending stock at higher price than you can close your short position on appearance of Doji pattern. This will result in good profit and will minimize risk of reversal. In case the trader is holding more than one short position in the stock than he can close 50% of the position this is how he can ride with the short position. Since the Doji is continuation pattern as well, so there is chances of further falling of stock. This is how he can make good profits.
- This also provide an opportunity to enter at lower price. If Doji emerging in downward trending stock than the trader can go long with 50% of the decided amount. In case stocks start moving up than he can put remaining 50% capital. This will result in lower average buying price and making good profits. In case the stock reverses than he will incur loss only on 50% invested amount. So loss will be less.
We recommend you to read first article on “Introduction to Technical Analysis“