Dragonfly Doji Pattern – Introduction
The dragonfly doji is a candlestick pattern in the field of technical analysis.
This pattern consists of a single candlestick and is known as a dragonfly doji because its shape resembles that of a dragonfly.
In this article I will teach you how to identify and profit from this pattern.
If you want a quick refresher about candlestick patterns, click here to read this article first.
Dragonfly Doji Pattern – What is it?
This pattern falls into the market reversal category and is part of the doji family.
The traditional formation of this pattern occurs when a security’s open, high and close are the same. However, we still consider it a valid formation when there is a little wick above the high. See the image below for a visual reference.
Potential setups with small bodies are not considered valid as the “body” of the candle must demonstrate seller exhaustion. Our experience suggests that the best dragonfly doji setups have a long downside wick which are usually 3-4 times greater than the “body”.
The dragonfly doji indicates indecision between buyers and sellers and a potential trend reversal. As such, it is considered a bullish reversal pattern.
As with all candlestick patterns, the location of the pattern is more important than the pattern itself. If a signal forms in the middle of a range, it is anyone’s best guess what happens next. Whereas, if the signal forms at a key level of support, it holds more weight for us!
Furthermore, the context of the pattern must make sense with what the market is doing. To this point, a dragonfly doji is most reliable when it forms after a period of recent selling pressure.
Dragonfly Doji Psychology
Now that you know how to identify it, let’s take a look at the psychology behind the pattern.
It is important to remember that candlestick patterns are a representation of market psychology so let’s break down what goes on behind the scenes when we see a dragonfly doji print on our charts.
As mentioned earlier, the most reliable dragonfly doji signals occur after a period of bearish momentum. This is because this is a bullish reversal pattern and MUST have a preceding bearish trend to reverse.
In the example above, let’s assume that we are looking at a daily chart of Crude Oil.
The last three days have seen sell pressure in this market and today’s session (marked in the red box) has started off quite bearish as we sold off on the open and are currently trading near the day’s low.
At this point of the day, we have a very bearish looking candle and sellers look to be in control. Market participants that aren’t already short see this weakness and look to get on board by selling the lows for a breakout trade lower.
The buyers suddenly show up near these lows and start to absorb the selling pressure. The sellers are unable to drive the market any lower and the buyers step in to bid the market back to the open.
The market closes the session right back where it opened, leaving a massive wick at the bottom of the candle as indicated in the example above.
So what happened? In short, we saw a change in market sentiment.
The long downside wick can be interpreted as a capitulation of bears. This signals that any remaining selling pressure in the market has likely run its course as the shorts scrambled to cover their positions.
At this point, we would expect for the market to respect the dragonfly doji as a bottom and for the buyers to follow through and drive prices higher in the next few sessions.
Trading the Dragonfly Doji Pattern
Now that you understand the psychology behind the pattern and know how to identify it, lets take a look at an example of how to trade it.
The image below is the daily chart of Pfizer.
Note how this security has been trading in a range between the upper bound ($30.85) and the lower bound ($27.85) for the last several months.
After rejecting the upper bound of the range on September 14th, Pfizer continues to sell-off for the next few weeks.
On October 15th, Pfizer gaps down 24 cents and opens at $28.19. Sellers take control out of the gate and manage to drive the security lower throughout the morning.
The buyers step in off these lows ($27.56) in the afternoon, reverse all the gains the sellers made earlier in the session and close the day back at $28.19.
Pfizer manages a range of 74 cents on the day (1.6 times the average true range), however, the bears come out with nothing to show for their efforts as Pfizer closes the session right where it opened. Another important thing to note is the higher than average volume that traded on this session without any gains for the bears.
This price action results in a dragonfly doji printing right at a key level of support which signals indecision between buyers and sellers at this level and that a potential bottom may be in here.
In order to confirm a bullish reversal is underway, we need to see the market trade back above the high of this doji candle ($28.30).
After this doji candle prints, Pfizer gaps lower the next session and drifts sideways for three sessions. Never closing below the low of the dragonfly doji candle.
On the 21st of October 2014, Pfizer gaps up and trades back above the high of the dragonfly doji triggering a long buy stop order.
After consolidating this level for another session, the buyers step in and drive Pfizer up almost 9% over the next month. Ultimately tagging a high of 17% from our entry before entering a two month consolidation phase.
This example shows the true power of the dragonfly doji when qualified correctly!
Dragonfly Doji Pattern – Final Thoughts
The dragonfly doji pattern is probably the most elusive pattern in the doji family so it is important to pay attention when you see one on your charts.
When combined with other confluence factors such as existing trend, support and resistance and volume spread analysis, the dragonfly doji pattern can be quite potent for traders.
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The information contained in this post is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.