If you have started your stock market training, you might have already heard about the inverted hammer candlestick. What is it about this candlestick pattern that makes it so popular among traders?
To answer the question, there are a lot of single candlestick patterns in the trading world, but only a few offer signals worth considering (thankfully). The inverted hammer candlestick pattern is one of those candles.
In this blog, we will share all the information that you need to be able to spot, confirm, and leverage this candle while technical analysis and forex trading. So, grab your cup of tea or coffee, and let’s get started:
What is Inverted Hammer?
The inverted hammer is a bullish reversal candlestick pattern. This candle, usually, makes an appearance at the bottom of a downtrend indicating that the buyers are trying to push the prices upwards.
Fun fact: It is supposed that this candlestick was named after a real-life hammer in an inverted position.
This candlestick pattern gives you a lot of perspective into what is happening in the market. Additionally, this candle can also give you an idea of the behavior of the bulls and bears in the market, within a particular time frame.
Just like the hammer candlestick pattern, an inverse hammer also helps the traders to pick out reliable points for price reversal in the market, during a price action trading day. Moreover, it further helps in technical analysis for the price action of the stock they wish to invest in.
Even though the structure is opposite, both hammer and inverted hammer are potential bullish reversal candlestick patterns.
Read more: 20 Stock market terms for beginners
Structure of an Inverted Hammer Candlestick
When it comes to the structure, it is basically an upside-down version of the hammer candlestick. Like any other single candle pattern in the trading world, the inverted hammer is also divided into three parts: body, upper wick, and lower wick or shadow.
Each part of the inverted hammer candlestick pattern has the following characteristics:
The more prominent part of the candle, which is broader than the lines on the top and/or bottom, is referred to as the real body of a candlestick. The body shows us the range between open and close.
The inverted hammer candlestick has a small body that is closer to the low. A small real body tells us that there is very little difference between the opening price and closing price during a trading day.
The Upper Shadow
If you see a line on top of the real body of a candlestick, know that it is the upper shadow or wick. This shadow tells you about the highest point that the price touched for a particular candle.
Unlike the hammer, an inverted hammer candle has a long upper wick. While trading, it is important to note that the extended upper wick should be, at least, twice the length of the body.
The Lower Shadow
The line emanating from the lower part of the body of a candle is known as the lower wick. This shadow tells you about the lowest point that the price touched for a particular candle.
The inverted hammer has a very small or no lower shadow suggesting that the bears are losing control.
How to Identify an Inverted Hammer Candlestick?
An inverted hammer candlestick pattern looks the same as a shooting star but trading experts know the difference. To identify whether it is an inverted hammer candle or not, you will have to consider its placement on the chart along with the other features mentioned below:
To differentiate an inverted hammer candlestick pattern while trading, you have to know that the inverted hammer candle forms at the bottom of a long downtrend. It is a bullish signal that indicates a trendline break.
If you don’t see it at the bottom of a downtrend, it means that it is not an inverted hammer candlestick. Simple as that! Look for signs to identify it as a shooting star.
Opening and Closing
The opening level could be above or below the closing prices indicating that the candlestick pattern can either be green or red. However, in the financial markets, a green inverted hammer candlestick is considered a stronger sign for a bullish trend reversal while trading.
At the same time, a red inverted hammer candlestick formation is also not a bearish version, but it is not an as strong signal of a bullish reversal as the green candlestick pattern.
Long Upper Shadow
The long upper shadow of the inverted hammer occurs when:
- The bullish traders start increasing the buying pressure to push the price upwards in the market
- The bearish traders reject the higher price and increase the selling pressure causing them to close the candle near the open
It shows that even though the bearish traders managed to bring the price near the opening level, they had little to no success bringing the prices further below.
This indicates that the bearish traders have lost control of the prices and the buyers are taking over to set the pace for an uptrend.
The inverted hammer candlestick pattern has an insignificant shadow at the bottom. This shows that the bears tried to maintain the downtrend in the market but they faced pressure from buyers.
During a trading day, when the bulls gain confidence after a long downtrend and the bullish trend is too strong for the buyers to resist, the inverted hammer is formed.
What Does the Inverted Hammer Pattern Tell You?
The inverted hammer candlestick pattern is suggestive of a potential bullish reversal in the market, indicating the onset of an uptrend. If you are a seller, it tells you to exit the market at a higher price. Whereas, it tells buyers to enter the trade early and make profits.
When the margin carries significant risk, it is better to opt for leveraged trading.
Why is Inverted Hammer Candlestick a Bullish Reversal Pattern?
The inverted hammer candlestick pattern is a good indicator of a bullish reversal because there is a lot of fluctuation in the prices when this pattern forms. This indicates that the bulls are testing the resolve of the bears to resist trade reversals.
Advantages and Limitations of the Inverted Hammer Candlestick Pattern
Let us, now, have a look at the advantages and disadvantages of an inverted hammer candlestick pattern:
The inverted hammer allows you to enter a trade at a favorable point. This means that you can enter the trade at an early stage to gain the benefit of the full upward movement.
You can easily identify this candlestick on the chart.
Reference: Best technical analysis indicators
As a single candlestick in isolation, the inverted hammer candlestick does not make much sense. So, while trading, you have to find a confirmation candle and refer to other indicators before entering a trade.
Besides, there is no guarantee of a reversal. Moreover, even if there is a reversal, it is short-lived. You will need derivatives to confirm your speculations.
In this regard, the Commodities Futures Trading Commission in the U.S. focuses on the regulation of market derivatives for off-exchange products.
As you might already know, many candlesticks could be identified as bullish reversal patterns in the market. However, you can’t entirely rely on candlesticks.
Therefore, consider your personal circumstances, other technical indicators, and the risks involved before entering a trade for any financial instrument. There is a significant risk so, if possible, seek independent advice and use risk management tools to gain confidence.
If you have started your trading journey recently and have any doubts, feel free to reach out to us. We will be happy to assist you!