Dragonfly Doji Candlestick: Bullish Reversal Pattern in Trading
Learn how to identify and trade the dragonfly doji candlestick pattern, a crucial signal for bullish reversals in downtrending markets. This guide will help you understand its significance and incorporate it into your trading strategy.
What is the Dragonfly Doji Candlestick Pattern?
A dragonfly doji is a unique and significant candlestick pattern that often signals a potential reversal in a downtrend.
It forms when the price opens, dips significantly lower during the session, but then rallies back up to close at or VERY near the opening price. The resulting candle has a long lower shadow with a very small or non-existent body, resembling a dragonfly.
This structure suggests that sellers attempted to push the price lower, but buyers stepped in strongly, hinting at a potential reversal of the downtrend.
How Does the Dragonfly Doji Candlestick Work?
The dragonfly doji works as a potential reversal signal during a downtrend. The pattern forms when sellers dominate the session initially, driving the price down, but then buyers regain control, pushing the price back up to the opening level.
This shift in momentum suggests that the market could be finding a bottom, with buyers stepping in to defend a key price level.
The long lower shadow of the dragonfly doji represents the sellers’ attempt to push the price lower, while the small or non-existent body indicates that they were ultimately unsuccessful.
Imagine a scenario where the market is dominated by selling pressure, but just before the close, the buyers manage to pull the price back to the starting point, signalling potential reversal upwards.
The presence of a dragonfly doji signals that a reversal may occur, especially if the following candle closes higher than the dragonfly doji’s closing price and there are other bullish confluences.
Let’s dive into how this pattern plays out on live trading charts.
Examples of the Dragonfly Doji Candlestick Pattern
The dragonfly doji candlestick pattern is versatile and can appear across various market structures and timeframes.
Here are some things to keep in mind when looking out for these candlestick patterns:
Market Structure: Dragonfly dojis usually form at the bottom of downtrends, signalling a potential reversal. They can also appear during uptrends after brief pullbacks, indicating trend continuation. For instance, in the BTC/USD Daily chart, we can see two dragonfly doji forming during a bullish uptrend after a minor pullback, both with large wicks showing strong buyer support.
Timeframes: Dragonfly dojis can be found on any timeframe, from 1-minute to daily charts. The SP500 1 hour chart shows a dragonfly doji that’s smaller than our other examples and on a lower time frame, but it’s still strong because we see a large gap up in price after the doji closes.
Validity: A dragonfly doji is most effective at key support levels or the bottom of a downtrend. For example, in the USOIL 4 hour chart, we see a very strong dragonfly doji form after a down trend AND at consolidation/support.
Key Characteristics:
- Wick Length: A longer lower wick indicates stronger reversal potential, as seen in our USOIL chart.
- Body and Colour: The body size is typically very small or non-existent, with the shadow being crucial. The dragonfly doji’s significance lies in the long lower shadow, showing the battle between buyers and sellers.
- Confirmation: The follow-up candle is essential for confirmation. A bullish candle following the dragonfly doji strengthens the reversal signal.
Case Study: SP500 Dragonfly Doji Pattern
On Monday, 1st July 2024, during the morning session of the New York market, the SP500 exhibited a textbook dragonfly doji pattern on the 1-hour chart.
This occurred after a brief but aggressive pullback in what was a clear macro uptrend, as seen in this zoomed-out chart.
Our dragonfly doji was exceptionally strong, featuring a small or non-existent body with a large lower shadow, indicating that sellers initially pushed the price down, but buyers swiftly stepped in, driving the price back up near the opening level.
The next candle closed with a strong bullish move, confirming the dragonfly doji’s reversal signal.
Following this, the price continued to rally aggressively over the next few hours, with the uptrend resuming in full force. This pattern highlighted a key buying opportunity for traders who recognised the dragonfly doji as a signal that the pullback was temporary and the broader uptrend was likely to continue.
Now we’ve seen a dragonfly doji candlestick in action, let’s explore practical strategies for trading it effectively.
How Do You Trade Dragonfly Doji Candlesticks?
The dragonfly doji candlestick can be traded in a variety of ways, depending on your trading strategy and market conditions.
If you don’t have a trading strategy and are new to the markets, here are three methods to consider when trading dragonfly dojis.
Method One: Trading Dragonfly Doji Reversal At Support Zones
A straightforward yet effective way to trade dragonfly doji patterns is by focusing on their occurrence at strong support zones, particularly in a macro bullish environment like the SP500 during all-time highs.
Let’s continue with our SP500 chart – first, we’ll zoom out to see the broader picture. This will help us understand how the market is consolidating at all-time highs and trading at an important support zone (yellow box).
In this case, we are trading in a strongly bullish market, where shorting near all-time highs is generally not advisable. Instead, the trend is your friend. As we can see, the SP500 had recently made a new high and then consolidated at that level.
The previous high, which acted as resistance, was flipped into support. Over several attempts, the price tested this level as support 4-5 times until our dragonfly doji formed, making a new swing low within this support zone.
The dragonfly doji candlestick that appeared showed a significant lower shadow, indicating that buyers had aggressively stepped in to defend the support level. The candle following the dragonfly doji closed bullish, giving us confirmation that the support level is holding, and a reversal might be in play.
Now that we’ve zoomed out to grasp the bigger picture and confirm the significance of this support zone within the macro uptrend, we can see that this dragonfly doji pattern, occurring at a crucial support level in a macro bullish trend, provides a powerful signal for a potential upward move.
The strategy here is simple: wait for the dragonfly doji to create a swing low at support, then confirm the reversal with the following bullish candle.
Once the confirmation candle closes bullish, we place a limit order at the dragonfly doji’s close, with our stop-loss positioned just below the dragonfly doji’s low.
For take profit, aim for the most recent swing high, aligning with the overall bullish trend.
By using this method, we can align our trades with the prevailing trend, avoiding the pitfalls of shorting in a strong bullish environment, and we secure a 3.4 risk-to-reward (RR) trade in only a few hours!
Trading Strategy Summary
Entry Point: Place limit long orders at the close of the dragonfly doji that forms at a support zone, but only after a strong bullish confirmation candle follows the dragonfly doji.
Stop-Loss: Place a stop-loss just below the low of the dragonfly doji.
Profit Target: Aim for the most recent swing high to capture the next move in the uptrend.
| PROS: Highly effective when trading in line with a strong bullish trend, providing clear entry points. Minimises risk by aligning with the broader market trend and placing stop-losses at strategic levels. |
| CONS: May result in missed opportunities if the price does not return to the limit order level. Requires patience as such strong support zones may not form frequently, limiting the number of trading opportunities. |
Method Two: 20-Exponential Moving Average Strategy
The 20-Exponential Moving Average (EMA) is a popular technical indicator among traders because it gives more weight to recent price data, making it more responsive to recent price changes. It’s been demonstrated to be an effective dynamic support for trending moves on many time frames.
Given the rarity and strength of the Dragonfly Doji, when this pattern wicks and closes above the 20-EMA, it often signals a strong bullish continuation.
For this strategy, we focus on Dragonfly Doji patterns that interact with the 20-EMA on lower timeframes, such as the EUR/USD 5-minute chart on August 28, 2024. In this example, the Dragonfly Doji forms, followed by a bullish candle.
The price then returns to the 20-EMA twice, respecting it as support, before finally closing below it on the third touch with a strong bearish candle.
To trade this setup, place limit orders on the close of the Dragonfly Doji, with stop-losses set just below the most recent swing low. This provides more protection against being wicked out of the trade.
The exit strategy is straightforward: close the trade when the price closes below the 20-EMA.
It’s important to note that different assets and timeframes may react differently to a moving average. While the 20-EMA is widely respected – especially in Forex and Stocks, other EMAs like the 50, 100, or 200 could also be considered, depending on your specific trading style and asset preferences.
Trading Strategy Summary
Entry Point: Place limit long orders at the close of the Dragonfly Doji that wicks and closes above the 20-EMA.
Stop-Loss: Set your stop-loss just below the most recent swing low for added protection. If the dragonfly doji IS the swing low – this is okay too.
Profit Target: Exit the trade when a candle closes below the 20-EMA.
| PROS: The 20-EMA is a dynamic support level, offering a clear entry and exit strategy. The strategy works well on lower time frames, where the Dragonfly Doji appears more frequently. |
| CONS: The strategy can produce false signals in choppy markets where the 20-EMA is not well respected. It may also require constant monitoring, especially on lower time frames. |
Method Three: RSI Divergence with Dragonfly Doji Candles Strategy
A powerful way to enhance the reliability of the dragonfly doji candlestick pattern is by combining it with RSI divergence, particularly when we see it occur in a strong uptrending market like our SP500 example.
This method builds on the previous techniques by adding a momentum-based confirmation to the mix.
Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements, typically on a scale of 0 to 100. Traders often use RSI to identify overbought or oversold conditions in the market.
When the RSI diverges from the price action, it can signal a potential reversal.
In our SP500 chart, after identifying a dragonfly doji candlestick forming at a key support zone, we also notice Bullish RSI Divergence. This is when price makes a lower low, but the RSI forms a higher low.
This divergence suggests that while the price was declining, the selling pressure was weakening, hinting at a possible reversal brewing under the hood.
When a dragonfly doji candlestick coincides with bullish RSI divergence, it becomes a powerful signal that buyers are stepping in as sellers lose strength. This combination greatly increases the likelihood of a successful reversal, especially in a macro uptrend.
In this instance, we see our dragonfly doji from the lower low in the price action, while the RSI diverges and forms a higher high. This, plus our bullish confirmation candle that follows, is our signal to look for long entries.
Following the same protocol as Method 1, we simply set a limit order at the dragonfly doji’s close, with a stop-loss just below its low. For our take profit, we’ll target the most recent swing high, staying in line with the bullish trend.
This gives us a 3.4RR trade in only a few hours!
Trading Strategy Summary
Entry Point: Place limit long orders at the close of the dragonfly doji that forms at a support zone, but only after confirming bullish RSI divergence and a strong bullish confirmation candle.
Stop-Loss: Set your stop-loss just below the low of the dragonfly doji to protect against potential reversals.
Profit Target: Aim for the most recent swing high to capture the next move in the uptrend.
| PROS: Combining dragonfly doji patterns with RSI divergence reduces the chances of false reversals. Confirms trades with underlying bullish momentum, improving success rates. |
| CONS: Multiple confirmations are needed—RSI divergence, a dragonfly doji pattern, and a bullish candle—limiting trade setups. Applying RSI divergence with candlestick patterns can be challenging for new traders. |
Method Four: Fibonacci Projection Target Strategy
This strategy utilises the Fibonacci retracement tool to target precise take-profit levels based on market retracements, focusing on dragonfly doji patterns during uptrends. It’s a refined and aggressive approach, so position sizing should be minimised.
As you’ll see, it can offer larger risk-to-reward setups, but entries may be considered ‘early’ by some traders who would prefer to see more confirmations.
To begin, configure your Fibonacci tool to display only the 2.5 standard deviation level. This setup will help you identify where the market might extend its move, providing you with clear take-profit targets. You can find the Fibonacci tool by clicking on the icons shown in the image below.
Looking at our SP500 chart once again, we see price makes a new all-time high and pulls back into our consolidation zone we established in Method 1.
As we are expecting this all-time-high to hold as support (it does 4-5 times), we are waiting for a new swing low to form.
When we see our dragonfly doji form this swing low within this zone we have two things:
- Confidence price wants to remain bullish given the nature of the candlestick
- The range we will create our Fibonacci with.
To do so, drag your Fibonacci retracement tool from this recent swing high to the swing low formed by our dragonfly doji candlestick.
The 2-2.5 standard deviation levels will now be plotted on your chart.
In some cases, you might consider aiming for more extended targets like the 4-4.5 standard deviations, especially if the initial risk-to-reward (RR) ratio is not favourable, such as 1-1.5RR.
However, in our current example, where we see a potential 10RR, targeting the 4.5 standard deviation level would be excessive and allow greed to cloud our trading judgement.
The strategy here is straightforward: after the dragonfly doji forms and a bullish confirmation candle follows, place limit orders at the close of the dragonfly doji. Set your stop-loss just below the dragonfly doji’s low, and target the 2.5 standard deviation level for your take-profit.
Targeting the 2.5STDV of this move gave us a winning 10RR trade!
Given the aggressive nature of this trading strategy, it would even be advised to take profits off at regular intervals in this move. The way you do this depends on your risk appetite. Some traders may take profits at 2RR, 3RR, 4RR, etc.
Others may move their stops to break even once the price hits a certain level and let the trade run ‘risk free’.
It depends on your style.
Trading Strategy Summary
Entry Point: Place limit long orders at the close of the dragonfly doji after a strong bullish confirmation candle. Use the Fibonacci retracement tool to define the entry range.
Stop-Loss: Set your stop-loss just below the low of the dragonfly doji to protect against potential reversals.
Profit Target: Target the 2.5 standard deviation level projected by the Fibonacci retracement tool.
| PROS: The Fibonacci projection offers specific take-profit levels, enhancing trade accuracy. This method capitalises on existing trends, making it more effective in trending markets. |
| CONS: Requires familiarity with Fibonacci tools, which can be challenging for beginners. Targeting distant levels like 4.5 STDV can lead to unnecessary risk, so it’s important to use discretion and target 2.5 STDV when conservative targets are more realistic. |
What if the Dragonfly Doji Appears During an Upswing?
When a Dragonfly Doji shows up during an upswing, it might not be as strong of a signal as it is after a downtrend.
Typically, this pattern is seen as a sign of a potential bullish reversal when the market is trending down.
However, in an upswing, it could be a warning that the price is hitting resistance, and the trend might be slowing down or even reversing.
According to a study by trading expert Thomas Bulkowski, the Dragonfly Doji only acts as a reliable reversal signal about 50% of the time. This means it’s not always a sure bet, especially in an upswing.
For this reason, it’s important to use additional strategies, like the ones we’ve covered in Methods 1-4, to confirm what the pattern might be telling you.
If you come across a Dragonfly Doji during an upswing, here are some simple steps to take:
- Check for Resistance: If the Dragonfly Doji appears near a known resistance level, it could mean the uptrend is losing steam and might reverse.
- Watch the Volume: If there’s low trading volume when the Dragonfly Doji forms, it could be a sign that there aren’t enough buyers to keep pushing the price higher, making the pattern less reliable.
- Use RSI for Confirmation: Look at the Relative Strength Index (RSI) or similar tools to see if the uptrend is weakening. If the RSI shows a divergence—where the price goes up, but the RSI goes down—it could be a sign of trouble.
- Be Wary of a Gravestone Doji: Keep an eye out for the Dragonfly Doji turning into a Gravestone Doji, which is a bearish pattern that could signal a downturn if the next candle closes lower.
- Combine with Other Tools: Always back up the Dragonfly Doji with other indicators like moving averages or Fibonacci retracement levels to confirm what you’re seeing before making a trade.
Dragonfly Doji VS the Hammer Candlestick Pattern
The only real difference between the Dragonfly Doji and Hammer candlestick patterns is the very slight variation in structure.
To some traders, they’re practically identical; to others, the devil’s in the details. The Dragonfly Doji has equal open and close prices, forming a “T” shape, while the Hammer features a small body at the top of its range.
Both signal potential reversals and can be traded similarly.
It’s worth noting that if a hammer forms during an upswing, it could be a Hanging Man pattern – a bearish signal that can lead to a potential price decline.
The most crucial takeaway? Both patterns can offer valuable insights into market sentiment.
Dragonfly Doji vs. Gravestone Doji Candlestick Pattern
The Dragonfly Doji and Gravestone Doji are both doji candlestick patterns, but they tell very different stories.
The Dragonfly Doji has a long lower shadow and signals potential bullish reversals, forming when the open and close prices are at the top of the candle’s range.
In contrast, the Gravestone Doji has a long upper shadow, with the open and close prices at the lower end, often indicating potential bearish reversals.
While both patterns suggest possible trend reversals, the direction of the reversal depends on the shadow’s position relative to the open and close.
The Dragonfly Doji hints at buyers stepping in after sellers pushed prices down, whereas the Gravestone Doji shows sellers gaining control after buyers tried to drive prices up. Understanding these nuances is key to interpreting market sentiment.
Think of the Gravestone Doji being the arch-nemesis or the exact opposite of the Dragonfly Doji – they are yin and yang.
Closing Thoughts on the Dragonfly Doji Pattern
The Dragonfly Doji candlestick is a candlestick chart pattern that signals potential trend reversals, making it a crucial tool in a trader’s arsenal.
Its unique structure and the insight it provides into market dynamics allow traders to make more informed decisions.
When paired with other technical analysis methods and disciplined risk management, the Dragonfly Doji can greatly enhance your trading strategies.
Advantages of Trading the Dragonfly Doji Pattern
- Reliable Reversal Indicator: The Dragonfly Doji is a strong indicator of potential market reversals, offering a clear sign that a shift in trend direction may be imminent.
- Versatility Across Timeframes: This pattern can be effectively utilised across a wide range of timeframes, from short-term trades to longer-term investment strategies.
- Insight into Market Dynamics: The pattern reflects a critical struggle between buyers and sellers, providing valuable insight into potential shifts in market momentum.
Disadvantages of Trading the Dragonfly Doji Pattern
- Requires Confirmation: Traders often need to wait for a follow-up candle to confirm the Dragonfly Doji’s reversal signal, which can delay entry decisions.
- Can Give False Signals: In strong, established trends, the Dragonfly Doji may occasionally produce false signals, especially if the confirmation candle doesn’t align with the expected reversal.
- Lack of Defined Exit Strategy: The Dragonfly Doji doesn’t offer a built-in method for setting price targets, requiring traders to rely on additional tools and strategies for determining exits.
Prove. Trade. Get Funded.
At FXIFY™, we believe in empowering traders with the capital and resources they need to succeed. Take on a challenge, pass the evaluation, and get funded with up to $400k in trading capital. Our performance splits go as high as 90% with add-ons at checkout, offering you the opportunity to scale your trading gains!
Join FXIFY™ today and GET YOUR FIRST PAYOUT ON DEMAND after your very first live trade on a funded account! No gimmicks, no fine print, no waiting periods, just true instant payouts.
FAQ Section
Is Dragonfly Doji bullish or bearish?
The Dragonfly Doji is generally considered a bullish reversal pattern, especially when it appears after a downtrend. However, its effectiveness depends on the confirmation candle that follows. If the subsequent candle shows a decline from the opening price, it may suggest continued bearish pressure instead of a reversal.
When does a Dragonfly Doji Candlestick occur?
A Dragonfly Doji typically occurs at the end of a downtrend, signalling a potential price reversal. It forms when the high and close prices are almost identical, creating a long lower shadow. This pattern indicates that buyers were able to push the price back up after sellers initially dominated the session.
What is the psychology of the Dragonfly Doji?
The Dragonfly Doji represents a battle between buyers and sellers, resulting in a stalemate where the opening price and closing price are nearly the same. This candlestick often signals bullish stubborness in the market, and when confirmed by a bullish candle, it suggests that buyers may have been successful in regaining control.
What is the success rate of Dragonfly Doji?
According to Thomas Bulkowski, the Dragonfly Doji acts as a reversal signal about 50% of the time. While it can lead to a bullish reversal, it’s crucial to watch the follow-up candle for confirmation. Its performance is stronger when used alongside other candlestick patterns to confirm the overall market sentiment and reduce the chances of false signals.
How does a Dragonfly Doji differ from a Gravestone Doji?
While both are types of doji candlesticks, a Dragonfly Doji candle forms with a long lower shadow, indicating potential bullish reversal, whereas a Gravestone Doji has a long upper shadow, suggesting a potential bearish reversal.
What are Doji Candlestick Patterns?
A doji is a candlestick that appears at the bottom of a downtrend and signals a potential trend reversal. It forms when the opening and closing prices are nearly identical, creating a long lower shadow with little to no upper shadow.
Can the Dragonfly Doji pattern appear in different timeframes?
Yes, this Japanese candlestick pattern can appear across various timeframes on a candlestick chart, from intraday charts to daily, weekly, or even monthly charts. Its significance as potential price reversals patterns remains consistent across these timeframes.
