Japanese candlestick patterns -The Doji

The Doji is one of the most important signals in Candlestick analysis. A Doji has the appearance of a cross, with the opening price the same as the close. It signifies indecision in the market (Figure 2).

Japanese candlestick patterns (Figure 2)

Other variations of the Doji are the Gravestone Doji and the Dragonfly Doji (Figure 3& 4). The Gravestone Doji shows price action that opens and closed at the bottom of its daily range, giving the bears a slight upper hand for the day and can be considered very bearish at a top. The Dragonfly Doji opens and closed at the top of its daily range and can be considered very bullish.

Japanese candlestick patterns (Figure 3)

Japanese candlestick patterns(Figure 4)

The psychology behind the Doji shows that buyers and sellers were even for the day, without one side or the other being able to get the upper hand to move the price of the stock. In an oversold market the Doji has very bullish implications and conversely, in an overbought market it has very bearish overtones. All Doji signals are enhanced by a long daily range, and overbought or oversold market conditions. Let’s look at a few charts and observe the Doji in different situations.

Japanese candlestick patterns -The Doji

The Basic Candles

To understand candlestick patterns, one first has to familiarize themselves with the basic candle types. In Figure 1, we saw a basic example of a black and white candle and most often these, or variations of the candles will be seen on the chart and will have no significant meaning whatsoever. These candles will be nothing more than random price movements without any clear signal for trading. However, there are some other variations of daily candles that you should familiarize yourself with before we go on to patterns. Some of these candles may carry important reversal implications when seen at the end of a long trend or at points of support and resistance. Many of these candles can give you an insight to the strength of a trend or a weakening trend. As we go through these candles we’ll explain the psychological implications of each and what may be happening as the buyers and sellers (Bulls and Bears) fight it out to move the price of a stock. Remember that all price movement is due to supply and demand. Try and visualize these candles as an indication of the daily battle between the Bulls and Bears so you can look at the larger picture of the price chart and assess who is winning the war. If you find yourself becoming confused between dark and light candle bodies, try to remember to look at each as if we were talking about the weather. A dark body has a stormy or bearish overtone and a clear body has a bright or bullish outlook. Enough analogies, lets move on to the candles.

Candlestick

Figure 1

The chart symbols used in candlestick charts are fairly easy to understand.
Candlestick charts get their name from the symbol used to represent the trading range in which you are charting (daily, weekly etc…), which are called candles. The candle has a wide area separating the open price from the closing price, which is called the body, Figure 1. On a trading day where the stocks price closed higher than its open, the candle will have an unfilled or clear body and on a day where the stock closes below the open price, the body will be filled (black in the example above). It’s important to keep in mind that a black candle does not necessarily mean the stock closed lower than the day before, just lower than the close. Conversely, a clear candle doesn't necessarily mean the stock closed higher than the day before, just higher than the open. On some charting software the unfilled bodies may be changed to green and the filled bodies to red. Many charting software also allow the user to change the colors themselves depending on their preference. The color of the body is not as important as the contrast between the two different candle types. For the illustrations in this article, we will use the traditional black and white bodies. On most candles there will be a thin line extending from the top and bottom of the body. The line extending from the top of the body represents the distance from the open or close (depending on the candle) and the high price of the day. Conversely, the line extending from the bottom of the body represents the distance to the low price. These lines are called the wicks, along with a variety of other commonly used names, such as whiskers
or hairs. Since candlestick theory puts its emphasis on the relationship of the open price, as compared to the closing price, the wicks rarely carry any technical significance. However, there are a few candles and patterns you will want to pay close attention to not only the wick, but also to the length of the wick.

Japanese Candlestick Charting

Candlestick charting was developed by Japanese rice traders over four centuries ago and could quite possibly be the oldest form of technical analysis. Since technical analysis is not only predicting probable price moves but also assessing market psychology, candlestick charting is probably the best tool to give the trader these answers in the shortest amount of time. Once a trader becomes familiar with candlestick charting, he or she can get a quick and highly visual signal because of the story candlesticks tell. Strict adheres to candlestick methodology take positions based on very short term patterns given by candlestick tradition. While candlestick charting is relatively unknown, and therefore unpracticed by the common investor, their use among active traders is growing. The greatest benefit candlestick charts provide the technical analyst is the ease of use and interpretation. The same price action, quickly seen using candlestick charts, may go unnoticed while scrolling through bar charts.
While analysis of chart patterns takes experience and some practice, so too will candlesticks. However, after learning the basic signals, candlesticks can provide the novice trader a shorter learning curve and also shorten the learning curve to chart reading in general. I like using bar charts to find chart patterns, and then switch to candlesticks for a closer look. Candlestick charts are especially useful when analyzing areas of consolidation such as triangles and flags for signs of reversal or continuation. The major signals in candlestick theory are reversal signals. Some of these signals are considered so strong by serious candlestick practitioners; they will enter a trade based on its signal alone, without the need for conformation. Since our trading style is to confirm everything, we won’t act on the signal alone, although we will pay close attention.
Our goal will be to teach you candlestick methods in their purest form, so we will alert you to the signals in which no conformation is said to be necessary. We will also break down each signal, expanding on its psychological implications on the chart. Our objective will be to not only educate you in the proper use of candlesticks, but also give plenty of examples of their improper use within a chart formation or pattern.