What is an Inverted Hammer Candlestick Pattern?

Formation of an Inverted Hammer Candle

The 'Inverted Hammer' pattern develops when a priceopens at a given level before rising sharply. The price reaches a peak before dropping sharply to close to its opening level. The candle can be both red or green.

If the closing price is less than the beginning price, the candle will be red. If the ending price is greater than the initial price, the candle will be green. Both have the name "Inverted Hammer."

Example of The Inverted Hammer Chart Pattern

Consider that you are keeping track of Wipro’s share price, which is declining and just closed at Rs.160.06. It starts at Rs.160.91 the following day and reaches a high of Rs.163.80 and a low of Rs.160.52 during that day. So, the price changes are as follows.

Open: 160.91 High: 163.80 Low: 160.52 Close: 161.38

The inverted hammer pattern results from Wipro's share price closing at Rs.161.38. The share price rose to Rs.166.55 during the following two days, confirming that the inverted hammer signified a bullish reversal.

How to Identify Inverted Hammer Candlestick Pattern?

Here’s how to identify the inverted hammer candlestick pattern for stock market trading.

Small real body: The candlestick should have a small real body, which means that the opening and closing prices should be close to each other. The body can be bullish or bearish, but it should be relatively small.

Long lower shadow: The candlestick should have a long lower shadow, which represents the lower of the session. The length of the shadow should be at least twice the size of the real body.

Little or no upper shadow: The candlestick should have little or no upper shadow. If there is an upper shadow, it should be relatively small compared to the lower shadow.

Inverted Hammer patterns are bullish reversal patterns that are more reliable when they appear during downtrends. You should also take into account additional to validate the inverted hammer pattern. For instance, the appearance of the inverted hammer following a downtrend may signal a potential bullish reversal. Instead, it could signal weakness or a potential negative reversal if it occurs following an advance.

Uptrending Inverted Hammer Candlestick

An inverted hammer pattern might predict a future trend reversal or a brief price decline in an upswing. The pattern can suggest that the enthusiasm among purchasers is declining. So, the price needs to retreat to support levels in order to draw in additional buyers.

Down-Trending Inverted Hammer Candlestick

When the Inverted Hammer candlestick pattern appears during a downtrend, it can be quite helpful. A bullish reversal may be approaching, according to this pattern, which also shows that the downtrend may be nearing its end.

Trading the Inverted Hammer Candlestick

To trade the Inverted Hammer candlestick pattern, follow these simple steps:

Find the pattern: On a chart, search for the Inverted Hammer pattern. Make sure it has the required elements—a small true body, a lengthy lower shadow, little to no upper shadow, and occurrence during a downward trend.

The Inverted Hammer pattern may indicate a bullish reversal, but it is necessary to wait for confirmation before making a trade. In order to confirm the reversal of the positive trend, you can wait for the price to pass above a resistance level or other technical indications, like a moving average crossing.

Set a stop loss: Once you've made a trade, it's crucial to put a stop loss to reduce your losses in case the share market swings against you. This might be positioned below a support level.

Set a target: Traders might target a certain price level of a stock using a signal or by finding a resistance level.

Risk management: Traders should also limit the amount of their positions and abstain from excessive trading.

Double Bottom

The double bottom is one of the most reliable reversal patterns. Its shape is similar to the letter "W" because it has almost two equal “lowest points”. These points lie at short distances from a modest peak.

The inverted hammer confirms a double bottom pattern at the “second bottom” of this chart. Both signs point to a market uptrend. To go long, a trader must wait until the market closes above the crest of the inverted hammer.

V-Bottom

It is another technical analysis pattern named after a letter. When price momentum shifts from an aggressive selling condition to an aggressive buying condition, it manifests with a form like the letter V.

Usually, the inverted hammer forms before a trader makes a move. Therefore, it's time to go long when the market closes above the inverted hammer's high. Remember that since these two patterns tend to bounce off trends, it is essential to trade them both with a support level.

Benefits of Inverted Hammer Candlestick Pattern

The following are the key advantages of trading inverted hammer candlestick patterns.

1. Easy to identify: It is simple to spot since it occurs close to the conclusion of a continuing downturn and has a long top wick in relation to the body of the candle. Because of this quality, even new traders can profit from the pattern.

2. Helps spot entry points: When paired with other patterns, it can be a very excellent indicator of entry into the market. A trader who enters the market early and uses this candlestick pattern may make money when the market turns around. Limitations of Inverted Hammer Pattern No doubt, the inverted candlestick pattern is quite beneficial. It does, however, have some drawbacks. They include the following.

1. While an upward reversal may occur after the discovery of this particular candlestick pattern, there is no assurance that it will do so for an extended period. The price of the security can drop further if buyers are unable to keep up their market strength.

2. Relying only on this pattern without considering further signals or the current situation could have undesirable effects.

3. In markets with less liquidity, the pattern might not be as dependable.

Conclusion

The inverted hammer candlestick appears on a chart when buyers exert pressure, signalling a potential positive reversal. To recognise an inverted hammer candle, look for one with a small body, a long top wick, and a short lower wick. Traders can tell if buyers are growing more confident in the market by looking at an upside-down hammer. When you detect the inverted hammer chart pattern, you can trade using derivatives like Contract For Difference (CFDs) or spread bets. When employing derivatives, you can trade rising or falling prices because you don't own the underlying asset.