The Doji signal denotes indecision. Its significance lies predominantly in the oversold and overbought conditions of the stock. At the top of an uptrend, when prices are in overbought conditions, it cautions the trader to start locking in profits. At the bottom of a downtrend, when prices are in oversold conditions, it foretells the trader that bears are getting tired.
In order for the Doji signal to be valid, the following conditions must exist:
1. The open and the close of the stock must be almost at the same price level.
2. There can be an upper shadow or a lower shadow or both.
The following Figure shows a Doji candle. The open and the close are the same or very near each other. What it implies is that prices had a wide range for the day, but ended up moving nowhere. The bulls and the bears had locked in in a fight. The supply of stock at that particular price was absorbed by the demand for it. The longer the upper and lower shadow, the more indecision it implies and the more forceful the trend once a decision is made. The Japanese say that a Doji in an overbought condition must be immediately acted upon. But a Doji in an oversold condition needs to see bullish candle the following day to conclude that the trend has actually reversed. There are a few other variations of the Doji signal which can be found here.
Variations of Doji signal
As you learnt from the Doji signal above, this formation basically implies indecision on the part of bulls and bears. There is a state of equilibrium. Supply is absorbed by demand. The Japanese say that when the market/stock is tired as it forms a Doji.
Here are a few variations of the Doji signal:
1. Gravestone Doji signal
Gravestone Doji signal
The Gravestone Doji is formed when prices open at a price, move up during the day, but end right back at where they opened. the Japanese compare it to soldiers who went to battle during the day and died and now rest in their graves. If this formation is seen at the top of an uptrend, it will potentially have bearish implications. Think about what the signal means. The bulls had complete control of the stock during the day. However they lost control to the bears, closing the candle right where it had opened. If the following day the bears can close the prices lower, the uptrend will be effectively reversed.
2. Dragonfly Doji signal
Dragonfly Doji signal
The Dragonfly Doji (named since it looks like a dragon fly) is formed if the prices open at a point, head lower during the day, but end right back at where they opened.If one sees a Dragonfly Doji at the bottom of a downtrend, it could potentially have bullish implications. The bears who had control of the stock during the day lose it to the bulls, thus creating this formation. If the bulls can confirm their strength the next day, the downtrend has a high probability of reversal.
3. Spinning Top
A Spinning Top is a small body candle. In a trend, when a Spinning Top is noticed after big tal candles, you can infer that the trend is losing strength. It does not necessarily mean that a reversal is about to happen. It only warns you about the strength of the trend.