Hammer Candlestick Pattern: Spotting & Using
There are many candlestick sequences that result in the full reversal of the previously strong trend. This reflects the change of the mood inside the particular market, and while you can’t always tell that the market is ready for a new trend, these patterns can help you with it.
The Hammer candlestick pattern is one of the many such patterns. It occurs when a strong negative trend falls drastically and then swings back during one candlestick period. After that, the price is supposed to rise rapidly.
That being said, you shouldn’t trust this pattern with all your heart. You might want to get a confirmation candlestick before jumping in. And even then, you’ll probably need several more indicators to make sure the trend is going to be positive from then on.
Spotting the Hammer
Hammer consists of the two candlesticks (it means that the entire process will only take 3 trading days to develop). Even so, the most crucial moments happen during the middle period. It’s an extremely short-term pattern. Some take months to develop, but this one is easy to miss if you don’t know where to look.
So, this pattern consists of three candlesticks, and here’s what they look like:
- A long negative candlestick. It shows that the price of security dropped significantly during the day.
- A shorter negative candlestick with a large shadow. The shadow is a grey line below the main candlestick body. The lowest portion of the candle shows where the price was at the end of the day, but the same point of the shadow shows the absolute minimum price. The length of the shadow needs to be much longer than the body’s.
- A positive candlestick that closes near the point where the first one opened. It can be slightly lower or higher, but they’ll still need to be on the same level.
The third day is meant for confirmation. The consensus is: if the third candle is positive and closes on more or less the same level as the opening price of the first candle, then it’s very probable that you’re looking at the beginning of a strong bullish trend.
Since the resulting shape resembles the letter ‘T’, the pattern was called the ‘Hammer candlestick’.
Reasons behind the Hammer
Hammer candlestick patterns don’t just occur on a whim. Patterns generally happen when an otherwise unchanging trend meets some new variable. In this instance, this variable is the increase in volume and supply.
Here’s how it goes:
- A bearish (negative) trend is going strong for some time (but still in a short span).
- At some point during one of the trading days, multiple sellers enter the market in an attempt to redeem the securities at a fixed price.
- The trend slows down and then swings up due to this new activity.
- At the end of the second day, the price change remains negligible compared to the opening numbers.
- If the reversal was strong enough, the trend will continue to grow by inertia.
Hammer candlestick pattern will not result in the long-enough positive trend – not unless something really influential changes the minds of the trading participants during this middle day.
That’s precisely why the long shadow is so important. It shows that the traders were willing to continue an extremely bearish trend that preceded the pattern development (the lowest point of the shadow indicates the lowest prices got during the day).
Since the prices change smoothly, it means that the sellers entered the market right after this extreme point in time. If it weren’t for them, the candlestick would be more-or-less the length of this shadow. Instead, the new sales returned the price back to the morning level.
Therefore, the shadow needs to be a lot longer than the candlestick. If it isn’t, then it means there was no strong force to throw the price back up. Without this force, the price won’t continue growing past the Hammer.
Remember: the longer shadow is in proportion to the body, the likelier your success will be.
Using the Hammer
So, given the shadow is 10x larger compared to the body, what do you do should you spot it?
In case you know for a fact that this pattern is going to be a bearish Hammer candlestick on the second day, then it would be very profitable to enter at the beginning of the third day. This way, you’ll be able to be a part of a big growing trend before it even develops.
However, it’s pretty hard to determine whether that’s the case. The perfect Hammers are rare, and when they happen, it’s often very hard to buy security because the demand will be off the charts.
In most cases, you’ll do well if you wait for the third day’s candle. As you remember, the closing price on the third day must be more-or-less on the same level as the opening price on the first day. Basically, the top points should match. If that’s the case, then it’s very likely that you’re looking at the Hammer. Entering the market, therefore, would be a priority the very following day.Yes, I want access to free training