Chartists look for “high-probability” patterns and set-ups in Japanese candlestick charts. While there are plenty of different patterns to look for, one that is particularly good at showing that a reversal could be in the offing is a “dragonfly doji.”
Dragonfly doji explained
A dragonfly doji is a candlestick pattern that indicates market participants might be indecisive. In other words, the bulls and bears are playing tug of war without any clear winner.
The dragonfly doji is formed when a stock’s opening, closing and high prices are nearly equal. Additionally, there is a long lower shadow, which suggests that supply and demand are balanced and that the direction of the trend might reverse.
Here’s how a dragonfly doji looks.
Keep in mind that you probably won’t see this exact pattern, so you’ll have to practice looking for candlesticks that look like this. The high price could be slightly higher than the opening and closing prices. With all technical analysis, nothing is perfect and setups don’t always play out as you expect. With this pattern, you’ll need to give it some “wiggle room.”
Check out the daily chart on the Guggenheim International Multi-Asset ETF (HGI).
Looking at the chart above, you’ll see a dragonfly doji-like pattern. The open and closing prices are nearly identical, but the high price was slightly above those prices. The stock was in a downtrend and looked as if it was putting in a double bottom. After the dragonfly doji, the stock reversed and broke out of its previous downtrend. Moreover, the 20-day simple moving average crossed above the 50-day moving average, indicating the stock was building momentum to the upside.
The dragonfly doji pattern is pretty difficult to find, but if you spot the pattern in a trend, it could potentially be a high-probability reversal trade. To improve your results, use this pattern in conjunction with other technical indicators or patterns, such as support and resistance, or moving averages. When the dragonfly doji pattern is used in conjunction with other technical analysis tools, it increases the probability of the trade working out.
Taylor Conway is the lead day trader at PennyPro.com. He is a short-term day trader of stocks and ETFs.