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A doji candlestick is where the opening and closing prices are very close, suggesting a trend where both bulls and bears try to dominate the market, but neither of them succeeds.
What is a dragonfly doji?
A dragonfly doji is one of the four candlestick patterns, indicating a possible price reversal trend. It forms when the opening, closing, and high price points are almost the same, while the low price point is very far from the three.
This candlestick suggests that there may be a price reversal after an uptrend or downtrend in the market. So, if the earlier price action has been in an uptrend, a dragonfly doji hints at a price fall and vice versa.
How do you identify a dragonfly doji pattern?
This candlestick gets its name from the shape it takes – it looks like a dragonfly.
The wick on top is almost invisible, as the high price point is more or less the same as the open and close price points.
The lower wick is long, indicating the low price point is far from the others.
Deciphering the dragonfly candle
When the market has been in an uptrend, i.e., prices are increasing until a point of resistance, a dragonfly doji forms at the top of the chart. It indicates that the prices may fall from that point.
Similarly, in a downtrend market where prices fall until they reach a point of support, a dragonfly doji forms at the bottom of the chart, suggesting an increase in price going forward.
The long lower wick shows a strong pull from the bearish traders in the market, trying to bring the prices down. But a strong force from the bulls takes the prices upward to the maximum point possible, and the stock is finally closed there.
Since bulls and bears are equally powerful here, the market is not influenced by either of them.
Trading based on the dragonfly doji
Traders usually wait for the next candle after the dragonfly doji to confirm the reversal trend. The pattern indicates that the market continues to be indecisive, and the dragonfly doji is a false alarm.
If traders can confirm the reversal pattern in the next candle, this may be the right time to trade.
Traders who do not want to take risks should wait for the price to go higher than the candle before the doji. The lowest point of the doji candle is considered the stop-loss point.
Dragonfly doji vs. Gravestone doji
While the dragonfly indicates a bullish reversal, the gravestone suggests a bearish reversal.
In order to identify dragonfly or gravestone candles, one must not look at where these candles form. Instead, the shape of the doji candlestick and the longer wick indicate whether it is a bullish or bearish reversal.
Limitations of dragonfly doji
Though price reversal is a common trend in the stock market, the formation of dragonfly doji is quite rare.
This is because it is not often that the high, open, and close price points are all the same.
The confirmation candle required after the dragonfly doji candle is also a rare formation. It does not always occur after a doji candle, which makes decisions difficult for traders.
Hence, the dragonfly doji, though powerful, is not a very reliable indicator for suggesting market patterns to traders.
Case study
Below is a sample dragonfly doji candlestick chart for HDFC as of February 2022.
Bottomline
Dragonfly dojis, as discussed, are a rarity. Hence, it requires immense practice and understanding of this concept in order to make decisions on this basis.
However, dragonfly doji used with other technical indicators may help predict accurate results. Additionally, it is essential to wait for the confirmation candle before taking any position based on the dragonfly doji.
FAQs
Yes, the dragonfly doji candlestick indicates a bullish pattern before the formation of the doji candle. Since this is a reversal trend indicator, the market becomes bearish after the formation of this doji candle.
A long-legged doji is not necessarily bullish or bearish by itself. It depends on the context and the direction of the breakout. A long-legged doji shows indecision and a possible transition in market sentiment. It may signal a reversal or a continuation of the prior trend.
A dragonfly doji is not a very accurate indicator of price direction. It only shows indecision and a possible trend change, but it needs confirmation from the next candle. It is best used with other signals and not alone.
The biggest difference between the two is that the dragonfly doji opens and closes at the same place. Conversely, a hammer opens at a lower price and closes slightly below its opening price. A dragonfly doji is often seen as a more reliable reversal indicator.
A perfect doji is a candlestick pattern that has the same open and closing price, forming a horizontal line. It shows a balance between buyers and sellers and a potential change in the market trend. It is a rare and neutral signal that needs confirmation from the next candle.