Hammer Candlestick Patterns: Demystifying The Potential Trend Reversal Pattern

Candlesticks patterns are reliable formations to indicate price movement. Though originated in Japan, it is now used worldwide by traders as a technical trading tool that helps them visualise price opening, closing, high, and low of a day in long candle-shaped patterns with upper and lower shadows. Hammer candlestick belongs to the same legion, is a price pattern candlestick.

Hammer candlestick has got its name from its unique shape. It has a relatively short real-body and a downward shadow that is twice in size of its body. The body of the candle represents opening and closing, while the shadow reflects the high or low the asset price has moved. Price action, along with the position of the hammer pattern, throws a revealing light on the market when viewed with the ongoing trend. It is, therefore, important for traders not only to be able to identify a hammer candlestick pattern but also to understand hammer candlestick meaning from a market perspective.

So, what is a hammer pattern?

Hammer candlestick is a unique candlestick pattern that indicates a potential trend reversal. Since it forms in a downtrend, traders associate the hammer with the return of bullish trend in the market. It is a short green candle with long lower shadow, which signifies lower price rejection by the market. Bullish Hammer is more common, but traders also recognise another hammer-like formation which they called the Inverted Hammer pattern.

Hammer candlestick appears in a downtrend suggesting bullish reversal. It has a short real-body and a long downward wick, thus resembling a hammer. It’s a green candle, unlike other red candles which formed before it. The closing price lies higher than the opening price, and the long shadow indicates presence of seller early in the market. But eventually, the market rejects the low price, and bull force pushes the price up.

Inverted Hammer

The Inverted Hammer also appears during a downtrend, has a long upper wick, which differentiates it from bullish hammer pattern. It also signifies potential trend reversal.

The inverted hammer is a short green candle. It implies that price rose high during the day, but eventually came down to close just above the opening, forming a short body.

Key Takeaways

  • Hammer is a price candlestick indicates a potential trend reversal
  • It forms around downtrend
  • A short real-body and downward or upward shadow is typical of a hammer pattern
  • It signifies price rejection
  • The lower shadow is twice the size of the real-body
  • Bullish hammer is more common, but inverted hammer patterns are also recognised by traders
  • When it formes, traders keep a lookout for confirmation, which is candlestick forming after the hamme

Interpreting Hammer Candlestick Patterns

Traders expect trend reversal when they spot a hammer. It occurs when the asset price is declining, indicating that the market is trying to find the bottom and an eventual shift in momentum. Formation of a hammer candlestick in the downtrend suggests an active day in the market – the price fell after opening but pulled back up to close at higher than the opening price – all happening during one period. Position of the hammer also bears vital signs. Traders consider it a strong signal if it precedes by three or more bearish candles. Also, the next candle forming after hammer candlestick should act as a confirmation and must close above the closing of the hammer candle. When all these occurrences fall into alignment, traders can consider it a strong enough signal of potential trend reversal and enter a long position. It is during the formation of the confirmation candle traders take a position to enter the market. But for like other candle formations, hammer candlestick patterns shouldn’t be treated alone.

Conclusion

Hammer candlestick signals a bullish trend reversal, but it should be considered with its limitations. Usually, the reversal isn’t confirmed until the next candle appears, which closes at a higher price than the hammer. A long shadowed hammer candle and a robust confirmation candle can push the price up significantly, making it difficult for traders to place a stop-loss and increasing their risk.

Further, a hammer pattern doesn’t indicate a price target. So, traders seek confirmation from other trading tools to guess potential risk-reward from the condition.