Market Reversal Pattern | The Northern Doji

THE NORTHERN DOJI (DOJI DURING RALLIES)

The Japanese say that with a doji after a tall white candle, or a doji in an overbought environment, that the market is "tired." That is a wonderfully apt way to view doji. A doji may not mean an immediate price reversal. The doji shows us the market is vulnerable, and may be at a transition point.

I received a letter from an attendee at one of my on-site institutional seminars. The attendee wrote, "You're right about a little knowledge being dangerous. We are all running around shouting 'doji, doji, doji!'" This comment is not surprising since doji are so easy to spot. Traders may get so excited about seeing a doji that they jump on it as a trading signal. But don't make more of the doji than it is meant to show. A doji means the trend may be in the process of changing.

For example, in my advisory service, I provide short-term trend. When a doji arises, I don't change the market's shortterm trend from up to down, but from up to up/neutral. If this doji also confirms another technical signal, then I would change the trend from up to neutral or neutral/down. (This idea of one technical indicator confirming another is the focus of Part 2.) It is rare that with a doji itself I would change the short-term trend from up to down.

In Exhibit 6.7 the spinning tops at A and B were clues that the trends before these candles were stalling. While such small real bodies represent a tug-of-war between the buyers and sellers, a doji is a session in which the bulls and bears are in complete balance.

During the ascent from B a series of long white real bodies echoed a vibrant market. The doji, in a single session, shows that the market is separating from its trend. The doji indicates that there is something very different on that day (in which the open and close are the same) from the preceding white candle lines where the closes were well above the openings.

In this example, after the doji, the index went from up to lateral and then down. However, the appearance of the doji doesn't necessarily mean the market will descend. Yet, the doji, especially in such an overbought market, would be reason for caution. Liquidating some long positions, selling calls, and moving up stops are all examples of what could be done with this doji session.

In Exhibit 6.8 the stock retreated from a bearish engulfing pattern (at B). A few sessions later a lengthy white candle showed that the bulls have taken control since that line closed over the bearish engulfing pattern's $58.50 resistance area. But the next session's doji changed the outlook. The market went from one where the bulls were in charge to one where, as shown by the doji, the forces of supply and demand were in equilibrium.

Observe how the stock stalled a couple of sessions after the doji neared $58.62. This brings out a useful technique I use frequently with a doji following a tall white candle. Specifically, I

Exhibit 6.7. Dow Jones Industrials-Daily (Doji after a Tall White Candle)

Exhibit 6.8. Microsoft 3-Minutes (Doji after a Tall White Candle)

will take the highest high between the doji session and the tall white candle (that is, the highest upper shadow). That level should be resistance based on the close. In this example, the high of the doji session and the long white candle were both $58.62. At such, that becomes our resistance area.

In Exhibit 6.9 sessions 1 through 6 had higher highs, higher lows, and higher closes. Session 7 was the first lower high, lower close, and lower low since candle line 1. Normally this is not of great consequence, but since candle 7 was also a doji, it adds more importance to this aspect. Sometimes the small clues add up to signal an important market juncture. As the Japanese proverb says, "The water of even a great ocean comes one drop at a time." So it is in the markets, where small clues that are not meaningful by themselves take on more weight when combined with other technical clues.

The dashed line on the chart is our resistance area once the doji emerged. As explained in Exhibit 6.8, if we have a doji after a tall white candle, we take the highest high between those two lines and make that resistance based on the close. In 

Exhibit 6.9. Intel-Daily (Doji after a Tall White Candle)

this chart, since the white candle line had a higher high than the doji's high, that becomes our prime resistance area (shown by the dashed line). With the appearance of the doji, Intel had become "tired." If Intel had closed over that resistance line, we would say that the market is refreshed and it would be a bullish breakout.