Candlestick charts are the most widely used charts by traders.
That’s because watching candlestick charts are like watching Game of Thrones.
Every day is a battle.
It tells us about the fight, the struggle, the defeat, and the victory in the markets.
Each individual candlestick is like the individual characters of a drama series…
And when you put these candlesticks together, they form patterns that unveil the plot about the markets and where it might be going.
In today’s post, I’m going to unveil yet another new character to this never-ending candlestick drama series…
And it’s from the same “Doji” species as the Gravestone & Dragonfly Doji that I’ve written in another post…
Enter the Long-Legged Doji.
By far the tallest of the Doji family.
And by the end of this post, you’re going to know exactly what is the Long-Legged Doji, and more importantly, how to trade it like the pros.
What is the Long-Legged Doji exactly?
If you’re searching on how to trade the Long-Legged Doji, then I assume by now you should be familiar with how to read a candlestick bar.
The Long-Legged Doji has 3 body variations:
The first one on the left-hand side has a bullish body where the close is above the open.
The second one in the middle has an open and close at the same place.
And the third one on the right-hand side has a bearish body where the close is below the open.
Now, here’s something that’s very important to understand about the Long-Legged Doji…
We do not determine whether it is bullish, bearish or indecisive by the color of the body.
For example, although the first Long-Legged Doji has a bullish body, it does NOT mean that it is a bullish candlestick.
Similarly, although the third Long-Legged Doji has a bearish body, it does NOT mean it is a bearish candlestick.
When reading a candlestick, you want to understand where the body is in relation to the whole candlestick bar.
If the body appears closer to the top of its formation, then it can be considered bullish.
And if the body appears closer to the bottom of its formation, then it can be considered bearish.
But we do not take a trade just because it is considered bullish or bearish.
We want to look at how this Long-Legged Doji is formed in relation to the market’s movement (which I will get into later in this post).
Now, you might be wondering what’s the difference between a normal Doji and a Long-Legged Doji?
Well, the difference is that the Long-Legged Doji has longer wicks than the normal Doji.
But what’s the significance of that?
This is something that I don’t see other people mention at all.
The significance of the Long-Legged Doji signifies volatility.
More specifically, higher volatility than normal.
This can be caused either by a news release, a technical analysis pattern breakout, or the start of a new trading session (i.e. first 30 minutes of the stock market opening or transitioning from the Asian Session to the London Session in the Forex market).
Sometimes this can be considered a good trading opportunity…
And sometimes it can mean that you should sit on your hands and do nothing.
As Bill Lipshutz said:
Now, as I mentioned at the beginning of the post, every candlestick bar tells a story…
And we want to understand this story so that it can give us a better picture of how to trade the Long-Legged Doji when it appears.
For this, we need to get into the psychology behind its formation.
The Psychology Behind A Long-Legged Doji
While many people say that Dojis are supposedly “indecision” candles, that’s not actually the case…
Because depending on the formation, it could be bullish or bearish as well.
And that’s no different for the Long-Legged Doji.
For example, if the body of the Long-Legged Doji is located near the top, that is a bullish sign because it signifies a rejection of the lows.
And if the body closes near the bottom, then it is a bearish sign because it signifies a rejection of the highs.
With that said, it does not mean you go Long or Short just because it is bullish or bearish.
We want to trade it with context.
That is the key to trading any candlestick pattern profitably.
When trading candlestick patterns, there is one important rule…
And that is – NEVER trade any candlestick pattern as a standalone.
That means you don’t go Long just because you see a bullish candlestick pattern.
And you don’t go Short just because you see a bearish candlestick pattern.
Instead, you want to see the context, which means you need to consider a few things like…
Is the market trending up or down?
Is the bigger timeframe in an uptrend, downtrend, or moving sideways?
Is there any support & resistance?
Was there a piece of high-impact news that just got released, or is there high-impact news about to be released?
These are all contexts you must take into consideration before deciding to get into a trade.
Once you understand the context for the candlestick pattern formed, you’ll be able to know whether to go Long, Short or just sit on your hands.
Now, let’s get into how to trade the Long-Legged Doji like a pro.
How to Trade The Long-Legged Doji
First and foremost, you should realize by now that not all Long-Legged Dojis are tradable.
That’s the same with any candlestick pattern.
I once went to a forum thread where the thread creator was teaching everyone to enter a trade whenever a pin bar was formed.
While pin bars can be a very good entry signal, it’s definitely not a good idea to trade every single one.
The forum thread is now dead.
And if you trade the same way, you’ll share the same fate.
Don’t say I didn’t warn ya!
In fact, most of the time, you want to stay away from trading the Long-Legged Doji.
And you definitely want to stay away from it when it is abnormally long like this:
The reason why you don’t want to trade it when it’s abnormally long is that it will be hard to find a good risk-to-reward ratio.
Since the candlestick is so long, your Stop Loss would be so wide that when the market normalizes to its original volatility, it will take a long time for your trade to work out.
When trading volatility, it should be the opposite.
We want to get into the trade as the market’s volatility is about to increase.
Not enter when the volatility is at its peak and it dies down.
So how do you tell whether a Long-Legged Doji is considered too long?
There are two ways…
The first way is to visually see it on the chart like the one above.
You can clearly see that the Long-Legged Doji is much longer than the other candlesticks.
The second way is more mathematical.
And that is to use the Average True Range (ATR) indicator.
The ATR indicator tracks the average length of the bar over the past number of bars as defined by the trader.
So if the length of the Long-Legged Doji is 50 pips and the ATR has a value of 30 pips, then it’s considered too long and we want to avoid trading it.
Now that you know when not to trade a Long-Legged Doji…
How do you decide when it’s time to enter into a trade?
There are 3 ways.
1) Trading With Support & Resistance
The first way is to trade with support and resistance levels.
In the chart above, you will notice that there is a support level that I’ve drawn.
The market is generally in an uptrend as it is forming higher highs and higher lows.
On the left-hand side of the chart, the market did a pullback to below both the moving averages and then briefly went back up again.
This pullback created a swing low which we consider a support level.
The market then came back down a second time and tested this support level but did not break below it.
It then went back up and came back down to test it a third time, and this time it broke below it.
Then it came back up again and formed a Long-Legged Doji closing above the support level.
This is a sign that the support level might hold.
Now we need to look at the context to decide to go Long or Short.
Since the market is generally in an uptrend and the support level still holds, we are looking for a potential Long trade.
You should not go Long just at the formation of this Long-Legged Doji.
Instead, we will only go Long if the market closes above the high of the Long-Legged Doji.
In this case, the market did go up and closed above the Long-Legged Doji.
This is our signal candlestick to go Long.
Either go Long at the close of the signal candlestick…
Or wait for the market to pull back to the midpoint of the signal candlestick.
Stop Loss is placed below the low of the Long-Legged Doji and Take Profit is placed at either 1.5R or 2R.
2) Trading With Divergence
The second way to trade the Long-Legged Doji is with divergence.
If you have been reading all my other posts on this blog, you will realize that I love trading divergence.
It’s my bread and butter setup.
Similar to other candlestick patterns, the Long-Legged Doji can also be used to trade divergence.
Let’s take a look at an example.
In this chart above, I’ve plotted 3 indicators:
- 20 EMA
- 50 EMA
- Stochastic Oscillator
The EMAs are used to identify the general direction of the market.
The stochastic oscillator, in this case, is used as a reversal indicator.
That means when there is a divergence, it means there is a potential reversal trade.
On the left-hand side of the chart, you can see that the market is trending pretty strongly upwards as it is above the 20 EMA.
Since the market is in an uptrend, we are looking for the market to form either a double top or a higher high formation.
And on the stochastic oscillator, we are looking for it to form lower highs for our divergence.
In the chart, you can see that as the market went higher, it formed a Long-Legged Doji.
Now, at this point, we won’t know whether the market is forming a double top yet.
However, the stochastic indicator is already indicating a lower high.
So there’s a possibility of a divergence forming.
But we want to wait for the market to close below the Long-Legged Doji to confirm with what the stochastic indicator is indicating.
In the next bar, the market did close just below the Long-Legged Doji.
That is our signal candlestick to go Short.
We place our Stop Loss just above the high of the Long-Legged Doji.
Take Profit can either be placed at 1.5R or 2R.
Or if you’re a trend following system trader, then use a Trailing Stop Loss to let the market take you out.
3) Trading With Pullbacks
One of the best ways to trade with the trend is to trade pullbacks.
And this is the third way to trade the Long-Legged Doji.
So to trade pullbacks, we want to first identify a trending market.
In an uptrend, the market will form higher highs and higher lows.
And these higher lows are the pullbacks that we want to trade.
In a downtrend, the market will form lower highs and lower lows.
And the lower highs are the pullbacks that we want to trade.
We also want to add a filter to identify the right types of pullbacks to trade.
The filter we will use is the 20 EMA and 50 EMA again.
So in an uptrend, we will only trade the higher low pullbacks when the 20 EMA is above the 50 EMA.
And in a downtrend, we will only trade the lower high pullbacks when the 20 EMA is below the 50 EMA.
Let’s take a look at an example.
On the left-hand side of the chart above, the market had been in a strong uptrend and had bounced off the 20 EMA twice.
This signifies that the 20 EMA is serving as a dynamic support level.
On the third bounce, a Long-Legged Doji is formed.
Since the market had several bounces off the 20 EMA, there is a likelihood that it could continue to go up from where the Long-Legged Doji was formed.
However, we do not want to go Long immediately on its formation.
Instead, we want to wait for the market to close above it first.
The market did end up closing above it and that’s the signal candlestick to go Long.
Alternatively, you can wait for the market to pull back a little bit to the midpoint of the signal candlestick before going Long.
If you had missed this trade, there was another chance to get into a trade with a second Long-Legged Doji forming shortly after.
For the second Long-Legged Doji, you can see that it bounced off the 20 EMA and also the previous swing low which acted as a support level.
This is what we call Confluence, making this a high probability trade.
To go Long, wait for the market to close above its high.
Similar to the other trade setups for a Long trade, we place our Stop Loss below the Long-Legged Doji.
And again, either place your Take Profit level at 1.5R or 2R, or use a Trailing Stop Loss.
Regardless of what candlestick pattern you see, they are not meant to trade as a standalone.
Instead, the candlesticks should serve as an entry confirmation for your trade setup.
In the 3 ways I’ve shown you on how to trade the Long-Legged Doji, it could easily be replaced with another candlestick pattern.
For example, in the pullback trade setup, it can also be a Bullish Pin Bar, a Bearish Engulfing Pattern, or any bullish candlestick pattern.
The candlestick patterns serve your trade setup, not the other way round.
Professional traders do not go Long or Short just because they see a certain candlestick pattern.
But rather they take a trade once all the other criteria of their trade setup are met, and the candlestick pattern is their entry confirmation.
Remember, context comes first before candlestick patterns.
Once you know the context, then you will know what candlestick patterns you are looking for.
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