The Double/Triple Doji: Have We Been Warned?

 Guest Author:  William Kurtz is the founder and CEO of CandleWave LLC.

The chart patterns from October 1987 (Black Monday) and May 2011 show creepily similar candlestick patterns.  One of the most important Japanese Candlestick reversal warning patterns is the “Doji,” in which the Open and the Close during a given time period are the same, or very nearly so.  The appearance of a Doji at the top of a long price rise is a potent warning of a probable decline in prices. When two Doji arrive there, back to back, we take special notice.

The Two-day Triple Doji
 
On October 2, 1987, the first of two Doji appeared.  The Open and the Close of that Doji in the Dow Jones Industrials Index on that day were 2639.20 and 2641.00, respectively.  The second of the two Doji appeared on the next trading day, October 5, its Open and Close being 2641.00 and 2640.20 respectively.  (See chart below.)

Note also that, straight across the two Doji, the two Opens and the two Closes were so close in terms of points as to be considered together as a separate, third Doji, which in my book “Candlesticks For Brighties” I have characterized as a “Unique Triple Doji.”  “Black Monday” followed, a few weeks later.  From the Close of the second Doji on Monday, October 5, 1987 to the price Low on Black Monday, October 19, prices fell 962.60 points – a decline of 36.46%.

Does History Repeat?
 
The Doji pattern is eerily the same now.  Two Candlestick Doji appeared, back to back, on May 2 and 3, 2011. The Open and the Close of the Dow Jones Industrials Index on May 2 were 12810.20 and 12807.40, respectively. The Open and the Close on May 3 were 12806.40 and 12807.50, respectively.  Both of these patterns qualify as “Doji.” Note, especially, the closeness of the two Closes: 12807.40 and 12807.50 – only one-tenth of a point apart!  I will argue that these two Doji, back to back, also qualify together as a “Unique Triple Doji,” just as in the October 1987 example.

Possible Disaster

Today, prices in the Dow Industrials have declined 6.79% since these back-to-back Doji appeared early in May. A decline equivalent (in percentage terms) to the 36.46% falloff in October 1987 would put the Dow at 8138. However, I believe that the falloff which is now in progress has only just gotten started.  I believe that this decline will be much more severe than the one in 1987, and that it will take much longer to unfold.  Here’s why: Whereas the falloff in 1987 followed an intermediate High but did not represent a
switch of the underlying operative price trend from Up to Down, the situation now is just the reverse.  Namely: It is quite probable that the peak on May 2, 2011 marked a lasting peak and that the decline which has followed it does indeed represent a change of the underlying price trend from Up to Down. I think that the Dow Industrials will sink to 6470, which was its Low of early March 2009, and to much lower levels thereafter.

Precaution:  Not Every Time
 
Japanese Candlestick reversal warning patterns do not work every time.  However, when a particularly bearish pattern such as two back-to-back Doji appear at the top of a long price advance, the follow-on result can be devastating.

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