There are so many candlesticks in the trading world but you don’t have to learn about all of them, especially if you are starting out. However, you should not miss the hammer candlestick as it gives you insights that can help you to draft your next trading strategy.
So, in this blog, we will cover what the hammer pattern is all about and why should you know about it. Let’s start with the basics:
What is a Hammer Candlestick?
Hammer is a prominent candlestick pattern that most people refer to so they can understand the price action of the security they wish to invest their money in. Generally, a hammer candlestick helps price action traders to pick out reliable points for price reversal.
The hammer candlestick is indicative of a bullish reversal pattern. It usually makes an appearance after a bearish trend that has lasted for quite a while.
A bullish hammer typical appears after a long bearish trend and signals a bullish reversal.
Read more: List of candlestick patterns
Structure of Hammer Candlestick Patterns
A hammer is a single candlestick pattern that basically has a small body accompanied by a long shadow or wick coming out of the lower end of the body. A hammer pattern can be formed as any of the following:
Green (Bullish): It means that the closing price of the candle will be higher than the opening price.
Red (Bearish): It means that the opening price of the candle will be higher than the closing price.
It is important to note that the color of the body of a hammer candlestick does not matter much because the hammer pattern always indicates a bullish price reversal. Thus, the main aspect to be considered in a hammer candlestick is not the color.
So, what is it?
It is the lower shadow that you should focus on. You must also note that the effectiveness of a hammer pattern is decided by the length of its lower shadow in comparison with the candle’s body.
Ideally, a reliable hammer pattern would entail a lower wick that is, approximately, two times longer than the size of the body. An even longer wick indicates that there is an increased buying possibility because it shows more exhaustion to the price.
How is a Hammer Pattern Formed?
How about we answer this question through a story?
Here is the story of a candle on a typical day in the world of the stock market:
There is a candlestick pattern that opens at a certain price, let’s say Rs. 20. Now, the bears start selling the stocks causing the price to fall. When it falls to a significant level, the bulls take it as an opportunity to enter the market.
This causes the price to increase and, when the price reaches around the opening level, the body becomes smaller leaving a wick or shadow in the path. This long shadow at the bottom of the body indicates that the bears pushed the price downwards but they, somehow, failed to hold it there.
Read more: 20 Stock market terms for beginners
So, this is how a simple candlestick becomes a hammer pattern!
Example: What Does a Hammer Candlestick Pattern Tell You?
In layman’s terms, a hammer mostly tells you that there is a potential reversal as the bears have lost control over the market. However, there is a teeny-tiny detail that you should not miss. All hammers do not indicate a bullish reversal.
Banknifty was in a downtrend. When it reaches 18000, a hammer pattern appeared. This leads to a trend change [downtrend to uptrend].
So, in short, a hammer tells you that there are chances of a price reversal. However, it is not necessary that you take the trade as soon as you identify a hammer pattern. Instead, you should wait for a confirmation before taking any position.
When the next candle after the hammer pattern closes above the closing price of the hammer candlestick, that is all the confirmation you will need.
Why You Should Understand Hammer Candle?
Hammers are important because they are among the leading indicators that could suggest a shift in the bullish or bearish momentum in the market. Moreover, a hammer candlestick pattern also helps us to confirm or strengthen other reversal indicators appearing on the chart.
To top it off, a hammer also indicates that the selling pressure is about to end. Therefore, it acts as a signal for traders to close off their short positions.
Disadvantages of a Hammer Candlestick Pattern
When considered in isolation, a hammer pattern does not offer reliable information. Moreover, there is no certainty of price reversal even if the hammer candlestick pattern appears after a long bullish or bearish trend.
Plus, hammers do not help us to determine the price target. Therefore, it is quite difficult to assess the profits.
Facts to Consider When You See a Hammer
To become a good trader, you will first have to understand that you cannot rely on the hammer as your only indicator. Instead, you will have to incorporate other technical indicators along with the hammer to confirm your findings. After all, a hammer does not offer a guarantee for a winning trading strategy.
Reference: Best technical analysis indicators
Additionally, you must also remember that it is better to avoid the hammer candlestick as your point of entry. It is because your stop loss will be much further from your buying point.
Lastly, you must always analyze the effectiveness of the hammer by its position on the chart. A hammer is considered reliable only if it is found at the top or bottom of the trend. It is better to ignore a hammer if it appears anywhere else in the chart.
However, always remember to refer to other technical indicators for certainty.
The hammer is a trend reversal pattern that appears either at the bottom of a bearish trend (the hanging man) or the top of a bullish trend. For a hammer trading strategy to succeed, you will have to consider several other aspects like:
- Market context
- Candlestick location
- Other confirmations through technical indicators and tools
- Market momentum
If you have any questions or doubts regarding the hammer candlestick pattern or stock trading in general, feel free to reach out to us.