Hammer and inverted hammer are amongst the top candlestick patterns. They are key reversal signals that traders look out for. First, let’s understand the differences between a hammer candlestick pattern and an inverted hammer candlestick pattern.
Hammer Candlestick Pattern
The Hammer candlestick looks like a hammer, with a small body and a lower shadow at least two times greater than the body. The body is at the upper end of the trading range and there should be no upper shadow or a very small upper shadow. Overall, the shape looks like a hammer, hence its name. A hammer candlestick is found at the bottom of a downtrend and signals that, although the selling is still going on, the bulls have started to step in. The color of the candle body is insignificant but a white candle provides a more bullish signal than a black candle. A strong bullish day is needed the following day in order to confirm the Hammer signal.
Hammer candlestick patterns represent weakness of the bears. They pushed the price lower after the stock opened but were unable to hold the price at its lows by close. The sellers were able to bring down the price down but the bulls stepped in and took over.
The Hammer has the same shape as the Hanging Man. The difference is that the hanging man is found at the top of an uptrend whereas the hammer is found at the bottom of a downtrend. The hanging man is the bearish version of the hammer.
Inverted Hammer Pattern
The Inverted Hammer pattern is the reverse of the Hammer candlestick pattern. Unlike the hammer pattern that has a lower shadow, this pattern is comprised of one candle that has a small body with an upper shadow that is at least two times larger. The open and close are near the low of the candlestick and there is no lower shadow or a very small lower shadow. An inverted candlestick is also found at the bottom of a downtrend and signals that the bulls have started to step in. Similar to the hammer pattern, the color of the small body is insignificant but a white body is more bullish than a black body. A strong bullish day is needed the next day in order to confirm the Inverted Hammer signal.
With an inverted hammer pattern, the buyers pushed the price higher after the stock opened but were unable to maintain it as some significant selling occurred. The stock closes near its opening price, with a rally in between. The presence of an inverted hammer signals a potential reversal upward.
The Inverted Hammer has the same shape as the Shooting Star. The difference is that the shooting star is found at the top of an uptrend whereas the inverted hammer is found at the bottom of a downtrend. The shooting star is a bearish version of the inverted hammer.
How to Trade Hammer Candlestick
During a downtrend, the bears are in control. The presence of a hammer signals that the bulls have started to step in. If the stock opens higher the day after Hammer day, a buy signal is triggered, confirming that the bulls have taken control and are trying to bring the price back up towards the top of the trading range.
There are certain signals that enhance the likelihood of a trend reversal. For example, the longer the lower shadow of the hammer, the higher the possibility of a reversal. If there is large volume on the inverted hammer day, it also increases the chances of a reversal.
Take a look at the below chart of SU.
On the day of the hammer, the price opened and started to trade lower. The bears were still in control but by the end of the day, the bulls start to take over, forming a small body with a large lower shadow. The body is bearish, where the price closed below the open price. During the day of the hammer, there was a larger trading volume, meaning there is a higher chance of a reversal.The day after the hammer, the price gapped up, confirming a buy signal. The bulls are attempting to bring the price back upwards toward the top of the trading range. This shows that the bears were not able to maintain control. When trading the hammer, put a stop loss below its lowest point.
A bullish day after the hammer is needed in order to confirm the trend reversal. This doesn’t always happen. For example, take a look at SRG below.
A hammer formed on low trading volume. Although a hammer formed, the price did not open higher the next day. Thus, a buy signal was not confirmed.
How to Trade Inverted Hammer Candlestick
The formation of an inverted hammer after a downtrend is bullish. The below chart of COST is an example of an inverted hammer pattern.
Prices stopped their movement downwards by rallying significantly during the day. However, sellers took control back and pushed prices back near the open. The body is bearish, where the price closed below the open price. The fact that prices were able to increase significantly during the day shows that bulls are stepping in. If the stock opens lower the day after the market forms an inverted hammer, a sell signal is triggered. Since the stock opened higher, a buy signal is confirmed. If you are selling below the low of inverted hammer, you should put a stop loss above the pattern’s highest price.
There are certain signals that enhance the likelihood of a trend reversal. For example, the longer the upper shadow of the inverted hammer, the higher the possibility of a reversal. If the body of the confirmation candlestick is large, the reversal long trade setup signal is stronger. If there is large volume on the inverted hammer day, it also increases the chances of a reversal.
The below graph of FB shows an inverted hammer followed by a bullish candle with a large body. This large body confirmed a strong trend reversal. You can go long on the trade and set up a stop loss below the Inverted Hammer candlestick’s close price.
It is important to note that a hammer or inverted hammer formation is not the signal to go long, but rather there are other indicators such as a confirmation candle that is needed the following day to confirm a buy signal. Although hammers and inverted hammers are reversal signals, they are not strong by themselves and need confirmation.
Understanding how to trade the inverted hammer candlestick pattern is just one of the many swing trading strategies.
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