What is a Dragonfly Doji?
A Dragonji Doji is a type of candlestick pattern that can signal a potential upside or downside reversal, depending on past price action. It is formed when the high, open and closed prices of the asset are the same. The long bottom shadow suggests that there were aggressive sales during the candle period, but since the price closed near the opening, it shows that buyers were able to absorb the sale and push up the price.
After a downward trend, the dragonfly candlestick may signal an imminent price increase. After an upward trend, this shows that more sales are coming to the market and that a fall in prices could ensue. In both cases, the candle following the dragonfly doji must confirm the direction.
Key points to remember
- A dragonfly doji can occur after prices rise or fall.
- Open, high and close prices match, and the lowest of the period is significantly lower than the previous three. This creates a “T” shape.
- The appearance of a dragonfly doji after a price hike warns of a potential price drop. A lower movement on the next candle confirms.
- A dragonfly doji after a price drop warns that the price could go up. If the next candle rises, this confirms.
- Candlestick traders usually wait for the confirmation candle before acting on the dragonfly doji.
What does the Dragonji Doji tell you?
The dragonfly doji pattern does not occur frequently, but when it does, it is a warning sign that the trend may change direction. After rising prices, the long bottom shadow of the dragonfly shows that the sellers were able to take control for at least part of the period. While the price ended closing unchanged, the increase in selling pressure during the period is a warning sign.
The candle following a potentially bearish dragonfly should confirm the reversal. The candle that follows must fall and close under the closure of the dragonfly candle. If the price increases on the confirmation candle, the reversal signal is invalidated because the price could continue to increase.
After a drop in prices, the dragonfly dragonfly shows that the sellers were present at the start of the period, but by the end of the session, the buyers had pushed the prices short. This indicates increased buying pressure during a downtrend and could signal an increase in prices.
The signal is confirmed if the candle following the dragonfly rises, closing above the closure of the dragonfly. The stronger the rally the day after the bullish dragonfly, the more reliable the turnaround.
Traders usually close trades during or shortly after the candle is confirmed. If you enter a bullish reversal for a long time, a stop loss can be placed below the bottom of the dragonfly. If you enter shortly after a bearish reversal, a stop loss can be placed above the top of the dragonfly.
The dragonfly doji works best when used in conjunction with other technical indicators, especially since the candlestick pattern can be a sign of indecision as well as an outright reversal pattern. A dragonfly doji with a high volume is generally more reliable than a relatively low volume doji. Ideally, the confirmation candle also has a strong price movement and volume.
In addition, the dragonfly doji can appear in the context of a larger graphic pattern, such as the end of a head and shoulder pattern. It is important to look at the whole picture rather than relying on a single candlestick.
Example of use of the dragonfly doji
Dragonfly dojis are very rare, because it is rare that the open, the top and the close are exactly the same. There are usually slight differences between these three prices.
This example shows a dragonfly doji that occurred during a side correction in a longer term uptrend. The dragonfly doji moves below recent lows but is quickly swept by buyers.
After the dragonfly, the price moves higher on the next candle, confirming that the price is going up. Traders would buy during or shortly after the confirmation candle. A stop loss can be placed below the bottom of the dragonfly.
The example shows the flexibility offered by candlesticks. The price did not drop aggressively when entering the dragonfly, but the price still dropped and then was pushed upward, confirming that the price was likely to continue rising. Looking at the big picture, the dragonfly pattern and the confirmation candle indicated that the short-term correction was over and the upward trend was resuming.
The difference between the dragonfly Doji and the tombstone Doji
A tombstone doji occurs when the low, open, and close prices are the same and the candle has a long upper shadow. The headstone looks like a Upside down “T”. The implications for the headstone are the same as for the dragonfly. Both indicate possible trend reversals but must be confirmed by the candle that follows.
Limitations of using the Dragonfly Doji
The dragonfly doji is not a common occurrence, so it is not a reliable tool for spotting most price reversals. When that happens, it’s not always reliable either. There can be no assurance that the price will continue in the direction expected after the confirmation candle.
The size of the dragonfly coupled with the size of the confirmation candle can sometimes mean that the entry point for a trade is far from the stop loss location. This means that traders will have to find another location for the stop loss, or they may have to give up the trade as too large a stop loss may not justify the potential reward for the trade.
Estimating the potential reward from a dragonfly trade can also be difficult since candlestick designs generally do not provide price targets. Other techniques, such as other candlestick patterns, indicators or strategies are needed to exit the trade when and if it is profitable.