How to trade the Gravestone doji

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This post explores the gravestone doji candlestick pattern and how to trade it. A trade plan for SPY on October 14 is also provided.

What is a Gravestone Doji?

A “gravestone doji” is a candlestick formation created when the open, low, and close all occur near or at the low of the day.  The signature aspect of the candlestick is the long upper tail or shadow. Typically these candlesticks appear after a pronounced bull run.  The candlestick has relevance on any time frame the trader is examining.







SPY puts in a “textbook” gravestone doji

On Friday, SPY opened with a $3 gap higher to $296.27 from Thursday’s close. Bulls then built on the open and put in a high at $298.74.  The high was faded into the bell closing just 2 cents from the open at $296.25.  The gravestone doji created from the price action is right out of the textbook.  A perfect example of a candle that is rare to begin with having the open, low and close all within pennies of one another.

Psychological implications of the gravestone doji

Let’s dissect the candle piece by piece in terms of price action.

Part 1:  Big Gap open higher:   Bulls “feeling it” as they are solidly in control. Some bears are likely covering early in the session

Part 2: Bulls drive price higher:  Bulls assert even more control as they drive price higher.  Yet even more bears are either forced to cover or take the pain of price going dramatically against them.  FOMO Bulls are piling in as they see the action.

Part 3 Big reversal.  Bears come out in force, sell into the advance and drive price back to the opening price.  Psychologically painful for late arriving Bulls. Whomever bought after the opening bell is now losing money with price below their entry price.

Taken as a whole, the gravestone doji is considered a bearish reversal candle because at the end of the day the bears were in strong control of the tape hanging late- arriving bulls hung out to dry.

Trading the following session after a gravestone doji

The comments here are specific to the SPY set up presented on Friday, but the idea can be extended to other gravestone doji set ups you may see in your trading.

As with all candlestick set ups, I like to see a confirming followup candle on the following bar. In this case, the gravestone doji is predictive of a red bar on Monday.  While a green bar would not totally invalidate the gravestone set up, it would chip away at the case.

For those trading the daily time frame

If you’re trading the daily time frame, you are most concerned with a daily close below Friday’s close of $296.25.  If price puts in a red candle, it will confirm that a new short term reversal is underway.  Traders should close their long if they bought into the rally at higher prices and take the loss as further downside would be favored.  If so desired, trader’s can flip bearish and initiate a short against $296.25 with a stop just above.

For nimble, active traders

Take note of the big $3 gap below $296.25.  Moves below $296.25 will favor a move to close that gap. If on Monday’s open, price moves below $296.25, initiate a short against $296.25 with a stop just above.  The target will be a gap fill down at $293.25.  If you get the move, think about covering all or at least 1/2 just shy of the target.  A bounce would be favored at $293.25.

If price moves higher off the open, above $296.25, while certainly objective to try a long against the open, I will not be taking that approach favoring instead to wait for a break of Friday’s low to get short.

What about QQQ?

While the candle formed in QQQ does not conform as well to the textbook gravestone definition, I’d expect QQQ to trade inline with SPY.  Look for a red candle on Monday for confirmation of a short term reversal.  Active traders can get short either on a break below Friday’s close or on a break below Friday’s low.

The Market rarely gives you the ideal set up

The above scenarios paint a rather straightforward scenario and a relatively easy game plan to follow. Unfortunately, the market rarely gives us such a simple scenario.

A scenario that would frustrate the most people would be a gap down Monday morning.  This would hang all buyers on Friday out to dry and deny them an easy exit.  It would also deny shorts of a “simple entry” just pennies below Friday’s close.  The gap down would put price in the middle of the $3 gap leaving a gap both above and below price thus leaving all traders guessing if price would back track to fill the upper gap to $296.25 first or head south to fill the lower gap to $293.25.   In this case, I like to let price establish an opening range for the first 15 minutes, then “go with price” on a break either above or below the opening range.   I am not good enough to trade off the first 5 minute candle, but if you are then by all means you are welcomed to take that approach. 

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The charts are and levels are provided as well-informed guidelines. That said, please be aware that exogenous events like surprise tariffs or other events can easily move price through support / resistance zones.

Also, set you stops according to your own risk tolerance. The ones I have provided are to be used only as a guide. The most important aspect of your stop is to honor them. Some trades work, some don’t. Honoring your stop will ensure your loss on a failed trade will be minimal.

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