It so happens that the doji is able to teach much of candlestick theory. If an undecided market contemplates retracement or pauses a while to reconsider the trend upon which it has embarked, this of itself will demand no alteration in price. When the market tests various levels and yet returns to its original price the premise is even more securely made. Here it is found that the greater the extension of the shadows on either side of the real body of the doji, the more pronounced the market’s reassessment. That the market has tested vast levels to the upside or to the downside as well is of great relevance to the issue of price discovery. When it has rejected these extremes to return not to a new found level of value but its original opening price, it is not merely a coincidence but an indication that momentum has come to an abrupt halt. For swing traders the doji must be understood in all its forms, for it provides one of the clearest signals for entry into the market or exit thereof.
When the market has tested the downside thoroughly and shows a doji at the peak of the candlestick with a long shadow extending downward, the contention goes to market strength rather than weakness; it has convincingly rejected lower prices and recovered to close at its highs – at its open. Still, the doji is an indication of indecision and needs further confirmation before entering the market. However, while the fact that an upper range has not been pursued balances out any bullish optimism, it may well be that the downside has been preoccupying the market however, and so the Dragon Fly Doji depicted below is inherently a bullish signal. When it occurs after sustained retracement it suggests a reversal is imminent, and when after an upward trending market, the suggestion that the trend has played out its natural course and has come to an end is patent.
Similarly, the Gravestone Doji below mirrors the Dragon Fly already discussed. Here the market has given extensive airing to the upside and has yet concentrated price discovery upon not only its lows, but its opening price. That the downside has not been more thoroughly explored is valid, but hardly able to dilute the bearish signal exuded. When at the end of an uptrend it clearly indicates a reversal is likely; when at the bottom of the market – indecision is rife, but any short positions ought to be covered.