Gravestone Doji Pattern – Introduction
The gravestone doji is a rare bearish pattern in the field of technical analysis.
It consists of a single candlestick and is referred to as a “gravestone” doji in Japanese candlestick literature. It represents the graves of the bulls that died trying to defend their territory (buying tops and chasing higher prices).
In this article, I will teach you how to identify and profit from bearish reversals with this pattern.
If you’re still new to trading price action with candlestick patterns, you’ll want to check out this post here first.
If you want to learn more about the bullish equivalent of this pattern, check out our post on the dragonfly doji here.
Gravestone Doji Pattern – What is it?
This pattern falls into the bearish reversal category and is part of the doji family.
The traditional formation of this pattern occurs when a security’s open, low and close are the same. If there is a small downside wick below the open, that’s fine! The pattern remains valid as long as it makes sense in the context of price action.
Potential setups with small bodies are not considered valid as the “body” of the candle must demonstrate buying exhaustion. Our experience suggests that the best gravestone doji setups have a long upside wick which is usually 3-4 times greater than the “body”. See the image below for visual reference.
The gravestone doji indicates indecision between buyers and sellers and will often signal a potential pullback (during bullish conditions). Or a continuation reversal (during bearish conditions).
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 resistance, it holds more weight for us!
To learn more about support and resistance click here to read this article.
Furthermore, the context of the pattern must make sense with what the market is doing. To this point, a gravestone doji is most reliable when it forms after a period of recent buying pressure.
Gravestone Doji Pattern – 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 gravestone doji print on our charts.
As mentioned earlier, the most reliable gravestone doji signals occur after a period of bullish momentum. Since this is a bearish reversal pattern, we MUST see a preceding bullish run to reverse. No run, no trade.
In the example above, let’s assume that we are looking at a daily chart of the DOW futures.
This market has seen aggressive buying pressure for the last three days.
Today’s session (marked in the red box) has started off quite bullish. The market ripped on the open and is currently trading near the high of the day.
At this point of the day, we have a very bullish looking candle and buyers seem to be in control of the market. Market participants that aren’t already long, see this strength and look to get on board by buying the highs for a breakout trade higher.
The smart money suddenly shows up near these highs and starts to dump inventory on the market. The buyers are now stuck and are unable to drive the market any higher. The sellers begin to step in aggressively, aiming for the day’s open in order to erase any ground the bulls made in the morning.
The session closes right back where it opened, leaving a massive wick at the top of the candle as indicated in the example above.
So what happened? In short, we saw a change in market sentiment.
The long upside wick can be interpreted as an exhaustion of the buyers. This signals that any remaining buying pressure in the market has likely run its course as the longs scrambled to close their positions that are now underwater.
At this point, we would look for the market to respect the gravestone doji as a short-term top and for the sellers to follow through and drive prices lower in the next few sessions.
Trading the Gravestone 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 the SP500 index.
Note the price action highlighted in the chart. The SP500 sold off aggressively after climbing to new highs on low volume. The bears mean business with this move as we can see the bearish candles are much larger relative to the bullish ones. We call this the impulse move.
After posting a low at $2528.25, the SPOOS rotate higher and initiate a deeper pullback. This counter-trend rotation lasts until a short-term daily swing high is printed at $2790 on February 27th, 2018.
The sellers step on this market the next morning and continue dumping inventory until we trade into the $2647 level three days later.
After this, we see another run at the previous short-term swings highs at $2790. The buyers manage a breakout above this level, however, they fail to sustain momentum and sellers take control into the close.
A textbook gravestone doji at a key level of resistance forms on March 12, 2018. This indicates a potential top may be in at this level. In order to confirm a bearish reversal is underway, we need to see the market trade back below the low of the gravestone doji candle.
Despite an early bid off the open the next morning, the SPOOS rotate lower and trigger the sell stop order sitting a couple ticks below the gravestone doji candle’s low ($2778.75). This session closes just off the lows with increasing volume. That is a good sign that the reversal is underway!
The market manages to trade down into the primary target at $2650 within the next two weeks. Ultimately dropping over 8% over the course of several weeks after the gravestone doji formed at the key level on March 12th.
This example shows the true power of the gravestone doji when qualified in the right context!
Gravestone Doji Pattern – Final Thoughts
The gravestone doji is probably the most elusive bearish pattern in the doji family so it is important to pay attention when you see one on your charts. If you do see one, a reversal may be coming, so get prepared to capitalize!
When combined with other confluence factors such as existing trend, support and resistance and volume spread analysis, the gravestone doji pattern can be used as a great additional qualifier to trigger trades.
We hope that you enjoyed this post and are now ready to apply the gravestone doji to your analysis.
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