What Is a Doji Candle Pattern, and What Does It Tell You?

What Is a Doji?

A doji (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, an inverted cross, or a plus sign.

Although rare, a doji candlestick, especially if it appears in clusters, generally signals a trend reversal indication for analysts, although it can also signal indecision about future prices. 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.

Understanding a Doji

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 do 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 represents 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 impending price reversal. However, it may also be a time when buyers or sellers are gaining momentum for continuing a trend. Doji is 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 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 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 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 and 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 that 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.

The Bottom Line

A doji candle chart occurs when the opening and closing prices for a security are just about identical. If this price is close to the low it is known as a "gravestone," close to the high a "dragonfly", and toward the middle a "long-legged" doji. The name doji comes from the Japanese word meaning "the same thing" since both the open and close are the same.

A chart depicting a doji suggests that no clear direction has been established for this security; it is a sign of indecision or uncertainty in future prices. The harami pattern is another signal in the market that is used in conjunction with the doji to identify a bullish or bearish turn away from indecision.