The Dynamic Doji

THE DYNAMIC DOJI SIGNAL

Doji Star

Description

The Doji it is the most recognized candlestick signal. Its formation, essentially looking like a cross, has relevant implications. It illustrates indecision during a specific time period between the Bulls and the Bears. The Doji is also com­prised of one candle. The Japanese say when a Doji occurs, one should always take notice. It is one of the most important Candlestick signals. The formation is created when the opening price and closing price are the same or nearly the same. This forms a horizontal line. It is an important alert at both the top and bottom of trends. At the top of a trend, the Doji signals a reversal without needing confirmation. The rule of thumb is that you should close a long or go short immediately.

However, the Doji occurring during the downtrend requires a bullish day to confirm the trend reversal. The Japanese explanation is that the weight of the market can still force the trend downward. The Doji is an excellent ex­ample of the Candlestick method having superior attributes compared to the Western bar charting method. The deterioration of a trend is not going to be as apparent when viewing standard bar charts.

Criteria

1.     The open and the close are the same or very near the same.

2.    The length of the shadow should not be excessively long, especially when viewed at the end of a bullish trend.

Signal Enhancements

1.     A gap, away from the previous days close, sets up for a stronger reversal move.

2.    Large volume on the signal day increases the chances that a blow-off day has occurred although it is not a necessity.

3.    It is more effective after a long candle body, usually an exaggerated daily move compared to the normal daily trading range seen in the majority of the trend.

A Doji at the Top

Illustrations in the following chapters will not have explanations of every indicator. The stochastic settings for all the charts are 12,3,3. The moving averages are the 50 day and 200-day simple moving averages. If a question of which is which, the 50-day MA will be the more volatile of the two.

The Doji becomes an extremely significant reversal signal when viewed at the top of a trend. The definition of a top of a trend is a function of the stochastic’s in an overbought condition. The Japanese rice trader’s scenario is easy-to-understand. After an extensive uptrend, the appearance of a Doji is an illustration the Bulls and the Bears have reached a point of equilibrium. The price has finally reached a level where the bullish buying pressure is being equalized by the Bears selling into them. A Doji at the top becomes an immediate sell signal. The Japanese Rice traders say to start taking your profits. A Doji in the over­bought condition becomes more relevant following a large white candle or a gap-up. A large white candle or a gap-up signifies the exuberant buying com­ing in at the top of a trend. That exuberance, followed by a Doji, becomes a very strong signal that a reversal is about to occur.

In early 2004, Fig.2-11, TASER International Inc. was the stock that just would not quit. It moved from the low single-digit price range up to the mid-30s in just a few months. Of course, it was well-publicized on the financial news stations. The higher it moved, the more it became debated as to whether it still had huge upside potential or was way over-priced.

If you were long, where did you take profits? If you are looking to short the stock, where did you want to get in? The Doji at the top in mid-April provided a very clear answer. Notice how the price of TASER stock started moving exuberantly in the first part of April, 2004. The long bullish candle, after a small gap-up, with stochastics in the overbought condition, should have been an alert to start watching for a candlestick ‘sell’ signal. That signal became clearly apparent the following day with a large Doji signal.

Fig. 2-11 TASER International Inc – early 2004

The Doji became the sell signal. The evidence of exuberant buying, fol­lowed by a Doji formation, would have allowed an investor to take profits near the very top of the trend. Could the price have continued higher? Certainly! However, remember that the Japanese Rice traders have analyzed these cir­cumstances for hundreds of years. The probabilities of a top reversal signal occurring is a function of witnessing exuberant buying followed by a gap up Doji signal. The Japanese Rice traders have recognized that this is time to sell. The gap-down open, the following day, clearly illustrates that the sellers have stepped into this trade.

If it is assumed that the signals have significance, then we would not be looking at them today if they did not work. Selling upon the appearance of a Doji is a high-probability profitable result. Exuberant buying followed by a Doji equals ‘sell’!

When the greed sets in, and the exuberant buying becomes visually appar­ent, be prepared to take profits. Viewing big price moves at the top of a trend, followed by a Doji, especially when that Doji gaps up at the top, take the prof­its. What is occurring when these formations occur? Investor sentiment decid­ing that everything is apparently so rosy for the future, they want to get in at any price. The question always needs to be raised “If everything is so great, who is selling?” The answer is usually the smart money.

The price of TASER International Inc. Fig.2-12, illustrated again the Doji at the top creating the reversal at the end of 2004. A long bullish candle, in the overbought condition, followed by a gap up Doji illustrates that the uptrend should be over. How do you exit the trade? Investors that have access to com­puter screens during the final 30 minutes of trading will be able to witness a Doji forming near the end of the day. They can close out their position on the close.

Fig.2-12 Taser International Inc. - late 2004

For the investor that does not have access to the markets during the day, the 'sell stop’ can be placed for the next days trading. A logical stop loss point would be at the low of the trading of the previous days Doji signal. If the selling came back down through that point, that would be a clear indication that the sellers had now started coming into the trade.

The gap-up at the top of a trend can have many conclusions. A gap-up followed by a long bullish candle has different implications than a gap-up that forms a Doji. As illustrated in the Photonics Inc. chart, Fig. 2-13, a gap-up Doji indi­cated the top of the trading. Profits should have been taken at the close of the Doji day or on the lower open the following day. Could a higher price have been achieved?

Fig. 2-13 Photonics Inc.

As seen in this chart, a better price could have been obtained approximately a week later. However, what is the main point of investing? To maximize your returns and to do so with the least amount of risk! Holding onto this position for another week would not have produced the percentage returns to make the risk of holding that position worth while. As can be seen, the majority of the profits were made when the price gapped up and formed a Doji.

The point of investing is not to maximize your profits on each individual trade. It is to maximize your profits for your account. The majority of the prof­its were extracted from this made at the gap up Doji. Those funds now should be moved to a lower risk trade, one that would have the upside potential as was seen at the beginning of this trade in mid to late January.

The appearance of a Doji at an important resistance level such as a trend line also has significance. Notice in Fig.2-14, the Cadence Design Systems Inc. chart, how a Doji, in the overbought, condition forms right at a trend line. The major advantage of candlestick signals is that they indicate immediately what the investor sentiment is doing at important levels.

Fig. 2-14 Cadence design Systems Inc

Witnessing a Doji, at what everybody else might be anticipating as a resistance level, provides an immediate confirmation that the buyers and sellers have participated in indecisive trading. The Doji illustrates that the trend-line has become resistance once again. It is further confirmed by seeing the selling the next day when prices gap to the downside.

Fig. 2-15 Harmonic Inc

If one Doji represents indecision, a series of Doji represents a lot of indecision. Finding a series of Doji is the set up for some powerful trades. Observing a series of Doji should alert investors that the Bulls and the Bears are having a hard time deciding which direction the trend should be moving. The more extensive the series, (the longer the indecision time frame) the more convinc­ing the trend will be once it breaks out.

A series of Doji is an excellent warning device. It illustrates that something is about to happen. Logically, if a series of Doji occur in oversold condition, what should occur is a move to the upside. Conversely a string of Doji, seen in the overbought condition, usually indicates the trend is about to turn down. The caveat to witnessing a large number of Doji forming is analyzing the previ­ous chart formations. A trading entity that has Doji forming a high percentage of the time will not be as significantly influenced by more Doji. A series of Doji becomes more significant when found in a normal trading chart.

As illustrated in Fig. 2-16, the Frontier Oil chart, after a mild sell-off the investors became very indecisive. This indecision occurred as the stochastics came into the oversold condition. One Doji, in an oversold condition, calls to the attention of an investor to watch for a reversal. Watching a series of Doji develop allows an investor to take advantage of a strong trend developing right from the very start.

Fig. 2-16 Frontier Oil Corp

What does a series of Doji represent? Indecision! What does the bullish candle illustrate after the series of Doji? The investors have now made up their mind which direction to take the trend. With that knowledge, it becomes an easy process to watch which direction the trading will move from that indecisive period. The candlestick investor can start putting on the trade as soon as the price movement has indicated that the indecision is over. A strong move, from an indecisive trading range, is an extremely high probability indicator. It can be acted upon immediately. An indecisive trading range can have many configura­tions. As witnessed in Fig. 2-17, the SIRF Technology Holdings Inc. chart, the indecision after the slight pullback could be viewed. The Doji illustrated that the downward trajectory was running into indecisive trading.

Fig. 2-17 SIRF Technology Holdings Inc

Although the stochastics were in mid-range, the series of Doji illustrated that the selling was waning, giving time for the stochastics to start curling to the upside. When the trading becomes indecisive at important moving averages, the investor should become aware of a potential trend change.

That scenario becomes relatively clear in Fig.2-18, the Champion Enter­prises Inc. chart. Doji/Spinning Tops occurring at a major moving average while stochastics are starting to move up should be watched. The appearance of a Long-legged Doji at the end of the series creates additional relevance. The indecisiveness is growing.

Fig.2-18 Champion Enterprises Inc.

Being prepared for a major consequence to occur allows an investor to make a purchase decision quickly. What is expected after a series of Doji? A significant move! If that is the case, a gap-up or a gap-down immediately illustrates what has been decided.

In the case of the Champion Enterprises Inc. Chart, Fig. 2-18, a gap up above the 50-day moving average, followed by the immediate buying, should have activated a purchase immediately.

Allow your eyes to evaluate what the major signals are doing. Keep it simple. As seen in Fig. 2-19, the Alamosa Holdings Inc. chart, a series of Doji indicated a bottom in early September. Another series of Doji occurred at the same level at the end of a month. The Bulls and the Bears were indecisive the first time the trend pulled back. The Bulls and the Bears were just as indecisive the second time the trend pulled back to that level.

Fig. 2-19, the Alamosa Holdings Inc.

Both times the series of Doji were revealing valuable information. Something should happen from these levels. The first rally failed. Is this not contrary to the implication that a series of Doji, followed by a strong move out of that trading range, should produce a strong rally? The key word is “probabilities”. Not all series of Doji are going to be followed by high profit trend. However, an ex­tremely high percentage of the trends will be strong.

The fact that the first trend failed does not negate the probabilities that the second series of Doji will have any less likelihood of being followed by a strong trend. Realistically, the second time the series of Doji indicated that there was great indecision at approximately the $7.50 level. A new buying indicator appeared. The gap up from the 50-day Ma and the stochastics curling back up. The sellers recognize the persistency of the Bulls.

A series of Doji occurring near a major moving average has significant implications. Two series of Doji at the same level, creating a double bottom formation, creates stronger implications. Will a series of Doji in the oversold condition always preclude a bullish trend? Will any series of Doji in the over­bought condition always preclude a bearish trend? No! The Doji indicate a major move is about to occur. The “probabilities” point to a bullish trend after Doji have formed in the oversold condition. The “probabilities” point to a bear­ish trend when Doji are viewed in an overbought condition. The important factor that the Doji portray is that a major move is likely to occur. As illustrated in Fig. 2-20, the Dick’s Sporting Goods Inc. chart, the series of Doji was just an indecisive congestion area in a strong up trend.

Fig. 2-20 Dicks Sporting Goods Inc.

One Doji, be prepared. Two Doji, be more prepared. Three Doji, definitely start looking for something major to happen one way or the other. This can be ap­plied to any trading entity. Whether you are analyzing the long-term trends in the indexes or trading minute-by-minute in E-mini S&P trades, the appearance of a large number of Doji becomes an excellent trade entry warning.