Doji Candlestick in Major Indexes Friday

Click on Chart to Enlarge

The chart above is the cash S&P 500, ticker $SPX. On Friday the major stock indexes gapped up slightly and then put in a strong first hour advance adding about 2%. After that, prices fell about 4% going about 2% lower than Thursday's close. Then in the last hour of the day, prices advanced about 2.5% to close the day almost unchanged from Thursday or from the open Friday.

The end result of this price action is called a "doji" candlestick pattern, and more specifically a "long-legged doji." A doji candlestick is one where the open and close are almost the same, so that the fat part of the candlestick just looks like a little crossways hash mark. When a doji occurs after a long downtrend (or uptrend), it shows that the market is in temporary perfect balance. I think of it as a ball in freefall. Then as the ball hits the ground, there is an instantaneous moment where the ball is perfectly motionless before being propelled upward by a strong reactionary force from the ground.

The doji is a fairly reliable candlestick reversal pattern in and of itself. However, if the following day is a strong day in the opposite direction of the prevailing trend, then the pattern is even more reliable. So Monday will give us a lot more information in this regard. There are other more subtle/detailed factors to look for that will give you additional information on the strength of the pattern. Here are some of the factors to look for:

1. the higher the volume, the more reliable the pattern typically
2. oversold technical indicators will help to assure market is at an extreme
3. pattern occurring outside bollinger bands should be more reliable since price is at a statistical extreme
4. pattern occurring inside the bollinger bands when prices have recently been outside the bands may be even stronger as it is a sign the current trend is weakening
5. when looking at a potential bullish reversal pattern, it is best if price closes in the center of the range (high to low) or higher
6. extreme sentiment readings help assure a market is primed for a reversal from a psychological perspective

In sum, Friday's action is suggestive of a strong reversal within the next couple days in my opinion. A large up day on Monday will give added confirmation of that outlook.