Understanding candlestick patterns is critical in technical analysis, and there are over 30 candlestick patterns. However, Doji candlestick patterns are the most common. While Doji Candlestick patterns can help traders make informed decisions, they can sometimes lead to false information. This piece will explain the Dragonfly Doji candlestick pattern, its components, how to trade it, and its limitations.
What Is Dragonfly Doji?
The Dragonfly Doji is a bullish reversal candlestick pattern usually formed at the lows of downtrends. Besides enabling traders to see support and demand, it can help investors detect an uptrend when coupled with other indicators. The Dragonfly Doji candlestick appears when the open, high, and closing prices become almost identical. The Dragonfly’s long lower shadow reflects that aggressive selling occurred during the underlying time that buyers counterfeited as the price closed near its origin.
What Does Dragonfly Doji Indicate?
After a downtrend, the Dragonfly Doji candlestick indicates that the price may rise. On the other side, the uptrend anticipates more sellers entering the market. Therefore the price could decline.
In either case, the candle that follows the Dragonfly Doji must confirm the market direction. The Dragonfly’s long lower shadow suggests that sellers had control for part of a price advance. While the price remained unchanged, the increase in selling pressure triggers a warning sign that the price trend might change. The candle appearing after a bearish dragonfly must confirm the reversal as it closes below the dragonfly candle. The reversal signal is invalidated if the price tends to rise on the confirmation candle.
Using Dragonfly Doji in conjunction with other indicators is best, as the candlestick patterns can indicate both indecision and reversal. Unreliability is associated with low volume Dragonfly Dojis. The confirmation candle should have a high price and significant volume.
Another possibility is that the Dragonfly Doji appears at the end of a head and shoulders chart pattern. Anyhow, traders should not entirely depend on a single candlestick pattern in any case.
Dragonfly Doji Examples
Since it is rare for a candle to have open, close and high prices to be almost in the same area, Dragonfly Dojis are not very common. Usually, all three prices do have minor differences. For instance, given below is an example of a Dragonfly Doji appearing in the sideways of a long-term uptrend. As the Dragonfly Doji moved lower, buyers quickly swept it higher.
The price moved higher after the Dragonfly Doji appeared, confirming the price retracement. Traders usually buy or sell their positions after the appearance of the confirmation candle.
Traders can witness the Candlesticks’ versatility as a slight drop in the price followed by a push higher confirmed the price was likely to rise further. Not to mention, the dragonfly pattern and the confirmation candle signaled the end of the short-term correction and the start of the uptrend.
This candlestick pattern implies different meanings when it appears in an uptrend or downtrend. Let’s discuss it below.
Dragonfly Doji in Uptrend
In a bullish trend, Doji candles always signal danger. A Dragonfly Doji candle appearing in an uptrend shows uncertainty in the market. It indicates a 50% price reversal or range before continuing upward movement. The next candlestick on every chart should confirm the Dragonfly Doji candle price action.
In the image below, a daily bearish Dragonfly Doji indicates a price reversal.
A bullish Dragonfly Doji followed a bearish one on a daily chart and prevented the price from falling. As a result of the candles’ strengthening, the price kept rising.
Dragonfly Doji in Downtrend
The downward trending candlestick is defended and pushed up by bulls to close almost precisely on the opening price. Thus, a Dragonfly Doji candle can signal price exhaustion and reversal. Also, it is pertinent to note the point when the candle appears since its formation near support could be a specific support level such as Fibonacci level, moving average line, historical support level, or Bollinger Bands lower band.
As seen in the image below, a daily bullish Dragonfly Doji showed a price retracement before continuing to fall.
A daily Bearish Dragonfly Doji formed below the support line, but the price did not retrace.
Trading the Dragonfly Doji
How to Trade a Dragonfly Doji?
As discussed above, It is rare for Dragonfly Doji to appear on charts. Therefore, it is comparatively difficult to open or close positions based on Dragonfly Doji candles. There is always a risk that traders might get confused while identifying the Dragonfly Doji. Mixing it up with a hammer candle or hanging man candle can lead investors to false interpretation. A T-shaped candle having a small body indicates that the price dropped below the opening price but closed on the same level after reverting.
Confirmation of Dragonfly Doji
Paying close attention to the candle appearing next to the Dragonfly Doji is crucial. For instance, a hanging man candle in an uptrend offers a high probability of reversing the price trend. However, be cautious since the price reversal pattern can also be false positives when appearing in higher time frames.
Upon reaching a resistance level, the formation of the Dragonfly Doji might indicate a temporary price reversal, but you should check it with further price action for confirmation.
Initiating a Dragonfly Doji Trade
Entering a position based on Dragonfly Doji carries increased risk since it signals the market’s uncertainty. Therefore, you must not forget to incorporate stop-loss while initiating a trade and open a position only after the appearance of the confirmation candle.
Difference Between Dragonfly Doji and Gravestone Doji
There is no difference between the practical implication of Dragonfly Doji and Gravestone Doji, as both suggest price trend reversals followed by confirmation candles. However, they look like opposite of each other. Dragonfly Doji is T-shaped with a long lower shadow, while Gravestone Doji appears as an inverted T with a long upper tail.
Limitations of Dragonfly Doji
Initiating trades based on Dragonfly Doji can be tricky since it only appears occasionally. Also, there is no assurance the market might move in the anticipated direction even after the appearance of a Dragonfly Dogi and the confirmation candle. Hence, relying on a less common technical indicator for spotting price trend reversal isn’t worth it.
Because of the magnitude of the Dragonfly Doji and the confirmation candle’s size, the entry position for a trade can be a long way from the stop-loss. It implies traders will either need to relocate their stop loss or abandon the trade position because a large stop-loss is less likely to justify the potential gain.
Secondly, you can’t estimate the potential gain reliably since Dragonfly Doji doesn’t help you define price targets. However, it will help incorporate other technical indicators and candlestick patterns while profitably exiting a trade.
Doji patterns imply a price transition or the market’s uncertainty about the future direction of pricing. Instead of a continuation or reversal pattern, these patterns are better classified as transitional candlestick patterns as a whole. Specific patterns, such as the Gravestone Doji or the Dragonfly Doji, indicate a potential price reversal, but they work best with other technical indicators.
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