Candle Sticks, an important part of Stock Market Technical Analysis is made up of a body that represents the price movement during the entire selected time frame. Every candle stick has four important price points which are open, close, high, and low.
What is a Hammer Candle Stick?
A hammer resembles the letter “T.” Hammer candle stick is one of the popular candle stick patterns. It is a candle stick where the opening price, closing price, and high (the top) are around the same price. It has a long wick that extends to the lowest price. The wick in a hammer candle stick is usually twice (or more than twice) the length of its body.
The body of this kind of candle stick resembles the head of a hammer and the long wick looks like the handle of the hammer. Hence, it’s named “Hammer Candle Stick”.
What is an Inverted Hammer?
An inverted hammer resembles an “inverted T”. As the name suggests, when a hammer candle stick, is flipped, we get an “inverted hammer candle stick”. For an inverted hammer candle stick, the open, close, and low will be at the same approximate price. The upper wick/shadow represents the higher price in the selected time frame.
Bullish Candle Sticks: Hammer and Inverted Hammer
Both hammer and inverted hammer candle sticks in Stock Technical Analysis are bullish candlesticks. They indicate a strong trend reversal signal. But it is important to note that the color of the candlesticks is not important. What matters the most is the place of its formation.
Hammers/Inverted hammers formed at the end of a downtrend, and major support lines are extremely significant as they have strong trend reversal probability.
When To Trade:
Hammers are everywhere on
the chart. Not all hammers/inverted hammers should be traded. Just like in the above picture, an inverted hammer/hammer should form at the end of a downtrend.
An appearance of a “full, green-bodied bullish candle”, with a small gap-up from the hammer/inverted hammer indicates confirmation.
A hammer at the end of a downtrend indicates a huge war between bulls and bears. The price pattern indicates, usual bears (who were strong because of the down move) trying to take the price to the “low”. The close price/high indicates a rejection of lower prices, thus bulls trying to push it upward. This indicates buyers have entered the market after a downtrend. It further signals to buy pressure thus indicating a trend reversal. The confirmation candle confirms the entry of bulls.
The same goes with an inverted hammer as the long upper wick clearly indicates the entry of buyers. A confirmation bullish candle signals an up move.
In a downtrend, usually, the selling pressure is strong. Despite the huge selling pressure, and the long wicks in the hammer, the inverted hammer represents the entry of buyers and buying pressure thus signaling an uptrend.
Bearish Patterns: Hanging Man and Shooting Star.
If the hammer and inverted hammer form at the end of the uptrend, then they are called hanging man and shooting star respectively. They indicate a strong trend reversal.
The hanging man/shooting star formed at the major resistance lines is considered highly significant. They indicate the end of an uptrend and a high probable start for the downfall of the stock’s price.
When To Trade:
It is easy to spot multiple shooting stars and hanging man patterns. Never trade all of them without any strategy. A confirmation candle should follow the hanging man/shooting star formed at the major resistance lines just like in the above picture.
Confirmation Candle: A strong-bodied bearish candle, with a small gap-down, indicates confirmation. It is important to take short trades only after checking the close of the confirmation candle.
- There should at least be a minimum of 3 bearish candle sticks before the formation of the hammer/inverted hammer.
- The color of the hammer/inverted hammer does not matter at all.
- The wick of the candle should be twice the body of the candle. Only then it is termed a hammer.
- Hammers/inverted hammers formed at the major support lines and at the end of a downtrend should be considered significant. Rest should be completely ignored.
- Never jump into the trade without a confirmation bullish candle.
- The time frame chosen is very important. Time frames like daily, and hourly, indicate a high probability of the success of the candlestick.
The initial bullish candles, preceded by the hanging man/shooting star represent the high strength of the bulls. These bullish candles indicate no sellers or selling pressure.
A hanging man/shooting star that has long wicks represents the selling pressure. Be it an upper wick or lower wick, the wick indicates the war between buyers and sellers. The buyers who were previously strong have witnessed an entry of strong sellers into the market.
Shooting stars at resistance indicate that the “buyers are losing control and giving way for sellers.” This is the main reason, the place of formation of those hammers is important.
How To Place Stop Loss and Target:
Stop loss: In both bullish and bearish hammer candlestick patterns, stop loss should be placed at the low of the hammer’s shadow.
Target: There is no set specific target. But mostly either the 3rd, 4th, or 5th candle forms the target depending on the strength of the candle.
The strength of both bullish and bearish hammer candle stick patterns depends on the number of bearish and bullish candles preceded.
Strength of the Hammer:
A hanging man is said to be more powerful if he follows the below three points. This applies to all the bullish hammer candle sticks and bearish ones.
- If the number of bullish candles preceding the hanging man is very high, then the hanging man is said to be a strong one.
- The strength of the hanging man candle is directly proportional to the time frame. The higher the time frame, the lesser will be the probability of fake signals.
- The confirmation candle should always be checked before taking the trades.
Limitations of Hammer Candle Stick pattern
Since a hammer candlestick does not take trends into consideration, more false signals are produced. It is difficult to place correct targets.
While taking up a trade based on the hammer, it must be combined with either support lines, trend lines, Fibonacci lines, etc.
Candlesticks are an integral part of the Technical Analysis of the Stock Market. One must have proper knowledge of the markets, before getting into the trade with little knowledge.