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Hammer Candlestick Patterns: How Do You Interpret It

30 Nov 2023

Introduction:

Candlestick patterns are one of the most dependable tools for predicting short-term price movements in stocks. Originally developed in Japan, they have become a globally adopted technical trading tool utilized by traders. These patterns aid in visualizing the stock's opening, closing, high, and low prices through elongated candle-shaped formations, complete with upper and lower wicks (or shadows).

In this article, you will learn about one such candlestick pattern – the hammer. The hammer candlestick pattern earns its name due to its distinct shape, resembling a hammer. It has a relatively small real body and long upper or lower wicks. The candle’s body signifies the opening and closing price of the stock during a trading session while wicks indicate the highest and lowest point the stock reached.

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When observed in conjunction with the prevailing trend, the position of the hammer pattern and price action can provide valuable insights into market sentiments. Hence, it is crucial for traders not just to know how to recognise the hammer pattern but also to understand its significance within the market context.

What are hammer patterns?

Hammer is a unique single-candle pattern that indicates a potential trend reversal. As it appears during a downtrend, traders link the hammer pattern to the potential resurgence of the bullish trend in the market. Represented by a small green candle featuring a substantially long lower wick (at least twice the size of the body), the hammer pattern signals the rejection of bearish momentum by the market.

Although the bullish hammer pattern is more prevalent, traders also acknowledge another similar formation known as the inverted hammer pattern.

The inverted hammer pattern usually occurs during a downtrend. It features a relatively small real body and a long upper wick, taking the shape of a hammer turned upside down. The formation of the inverted hammer pattern also indicates the possibility of a trend reversal. It suggests that the stock surged for a brief period during a trading session but ultimately closed just above the opening point.

Key components of hammer candlestick patterns

Below are the key characteristics that can help you identify hammer patterns on a price chart:

  • Small real body

One of the primary features of the hammer pattern is a small real body that can be bullish (green or white) or bearish (red or black). The colour of the body provides additional information about the prevailing market trend. However, it does not carry too much significance.

  • Long lower shadow

Another distinctive feature of a hammer pattern is its long lower shadow, representing a huge gap between the lowest price and the closing price. The longer the lower shadow, the more significant the hammer pattern is considered. 

In the case of an inverted hammer, the size of the body remains the same. However, the upper shadow is long instead of the lower shadow. It demonstrates the large gap between the highest price and the closing price.

  • Negligible upper shadow

A hammer typically has little to no upper shadow, indicating that the closing price is very close to the session’s highest price. Similarly, an inverted hammer has a negligible lower shadow, indicating that the closing price is very close to the session’s lowest price.

Trading strategies for hammer candlestick patterns

As mentioned, the appearance of a hammer pattern suggests potential trend reversal. Thus, you can determine your trading moves accordingly. Below are a few strategies you can consider:

  • Enter a long position

The hammer is considered a bullish reversal signal when it appears during a downtrend. It suggests that sellers attempted to push the price lower but were unsuccessful, and buyers regained control over the stock by closing, pulling the price back up. Forming this pattern can be an opportunity to enter a new long position or exit your existing short position.

  • Location on the chart

The location of the hammer on a price chart plays a crucial role. It becomes much more significant if it appears near the support level or trendline. It confirms that a change in bearish momentum is imminent.

  • Volume analysis

Analyzing the trading volume can provide additional confirmation of the trend change. An increase in trading volume simultaneously with the hammer formation suggests strong buying interest in the stock.

To conclude

The formation of the hammer pattern can be a significant signal for trend reversal. It can be an opportune moment to enter a long position or exit your short position. However, you must confirm your trading decisions with other technical indicators.

 

Related Articles:  Difference Between Shooting Star And Inverted Hammer Candlestick Patterns | How is a Notional Value Different from the Market Value

 

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