A hammer candlestick is a key notion in charting as this pattern helps traders identify and confirm a trend reversal – particularly when the market is about to turn bullish, showcasing the end of a bear trend. In this article, we’ll introduce you to the hammer candlestick, what it is, how you can identify it and how to successfully integrate it into your trading strategies.
What is the hammer candlestick in trading?
Among various chart types, the candlestick chart, or Japanese candlesticks, is a favoured tool among traders.
The appeal of this chart type lies not just in its simplicity and the wealth of information it provides, but also in the patterns or distinct shapes it forms. These patterns serve as indicators, signalling either a continuation of the current trend or a potential reversal in the market trend.
As shown in the picture below, the ends of the candlestick’s shadow represent the high and the low prices of the period, while the ends of the body represent the open and close prices.
These patterns are applicable across all types of timeframes (minutes, hours, days, weeks, months) and assets (stocks, indices, currencies, commodities, cryptocurrencies, bonds). One such pattern is the hammer candlestick formed by only one candle.
Its structure comprises a small candle body with a significantly longer shadow, usually about twice the length of the body.
Types of hammer candlesticks
There are two types of hammer candlesticks. Let’s look at each one of them:
Bullish hammer candlestick
The bullish hammer candlestick has a small body and a long shadow (typically twice the size of the body). It forms after a price decline and indicates a trend reversal (if it’s confirmed).
To be confirmed, the candle following the hammer candlestick should open above the close of the hammer candlestick and close above both the open and close of the hammer candle.
It is, therefore, a pattern that appears at the end of a downward trend and warns of a possible change of trend, from bearish to bullish.
Therefore, its characteristics, summarised, are as follows:
- The hammer candle has a small body and a long shadow (usually twice as long).
- The candle does not have an upper shadow (or it’s very small).
- The candle forms after a downtrend, usually after at least three consecutive decreasing candles.
- The hammer candlestick may appear at a support level.
- The hammer candlestick does not mean that buyers have regained control, it simply indicates that a bullish sentiment may be strengthening.
Inverted hammer candlestick
As the name suggests, the inverted hammer candlestick is the opposite visual representation of a hammer candlestick – in this case, the upper shadow indicates that the bearish trend may reverse. It’s important to note that both inverted hammer candlestick and hammer candlestick may indicate the reversal of a bearish trend. The opposite of these is known as a shooting star, which indicates the top of a bullish trend (hence a bearish movement may follow.
The inverted hammer candlestick pattern appears with a small body and a long upper shadow.
Like the classic hammer candle, the inverted hammer appears at the end of a downward trend and warns of a possible turn of that trend.
The opening of the candle is lower, then the price rises, but closes near the opening price.
Therefore, its characteristics are the following:
- It is a pattern that appears in the final phase of a bearish trend and warns of a possible change of the trend, from bearish to bullish.
- The candle has a small body.
- The lower shadow is very small or doesn’t exit.
- The upper shadow is much longer than the body.
- The confirmation of this pattern must be done by observing the following candle, which must close above the hammer candle.
- The smaller the body of the candle, the more reliable the pattern and the longer the upper shadow, the better.
How to identify a hammer candlestick?
Here is another representation of a hammer candlestick. As depicted below, the body is small and the lower shadow is long:
This candlestick appears at the end of a longer bearish trend, such as:
How to identify an inverted hammer candlestick?
Just like the hammer candlestick, the inverted hammer candlestick appears at the end of a bearish trend, and its upper shadow is longer than the body:
Guidelines for using the hammer candlestick
While chart patterns and technical indicators can be remarkably accurate, they are never infallible or absolute. Though they often exhibit a high degree of accuracy, they don’t guarantee success in 100% of instances.
Hence, to boost reliability and precision, it’s ideal for a hammer candlestick to appear at the conclusion of a downward trend, preferably in a region where another supportive element also enhances the likelihood of a price shift upward.
Key supportive elements can include:
- A support level.
- A Fibonacci level
- A moving average (10, 20, 50, 100 or 200).
- That a technical indicator indicates oversold, such as the RSI.
Practical example of a hammer candlestick
Let’s consider an instance where a bullish hammer candle formed in Banco Santander’s shares.
After nearly two months of decline, a candlestick appeared with a small body, a very small upper shadow, and a lower shadow twice the size of the body.
The next candle opened above the hammer candle’s closing price and closed above both the opening and closing prices of the hammer candle.
Following this, the trend reversed from bearish to bullish.
Practical example of an inverted hammer candlestick
Now let’s examine an instance where an inverted hammer candle appeared on the Ibex 35 index.
Following a month and a half of decline, a candle emerged with a small body, a very small lower shadow, and an upper shadow that was twice the size of the body.
The next candle opened and closed above the body of the inverted hammer candle, then the trend turned from bearish to bullish.
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Hammer candlestick: summary
Understanding the hammer and inverted hammer candlestick patterns can provide traders with crucial insight into potential market reversals. While these patterns alone should not be the sole basis for making trading decisions, their occurrence at key support levels, Fibonacci levels, or moving averages can significantly bolster their reliability. Remember, the candle that follows the hammer or inverted hammer should confirm the reversal before a trade is executed.
How reliable are hammer and inverted hammer patterns in predicting market trends?
While these patterns can provide strong signals for potential reversals, they are not infallible. Traders should use them in conjunction with other indicators.
What does the colour of the hammer candlestick body signify?
In the context of a hammer or inverted hammer candlestick pattern, the colour of the body is generally less significant than the pattern itself.
How can a trader distinguish between a valid hammer or inverted hammer pattern and a false signal?
A valid hammer or inverted hammer pattern is usually confirmed by the candle that follows it. Without this confirmation, the pattern could be a false signal. Traders should also consider the overall market trend and use other technical indicators for further validation.