What is Hammer Candlestick Pattern?

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  • 12 Apr 2024
What is Hammer Candlestick Pattern?

Key Takeaways

  • The Hammer Candlestick Pattern occurs after a downtrend and signals a potential bullish reversal or a pause in the bearish momentum.

  • The long lower shadow indicates that sellers initially pushed prices lower, but buyers eventually regained control.

  • There are two main types: Classic Hammer, which has a small body and long lower shadow, and Inverted Hammer, which has a small body and long upper shadow.

  • You have to look for a long lower wick, a small real body, and formation during a downtrend to recognize a Hammer Pattern.

  • Setting a stop-loss below the Hammer's low and identifying potential resistance levels for taking profits is crucial.

  • The higher trading volume during the Hammer formation adds credibility to the reversal signal.

The Hammer Candlestick Pattern appears after a period of falling prices. This type of candlestick has a small body and a long shadow at the bottom. To understand it well, let’s consider an example.

Suppose that the Indian stock market has been experiencing a bearish phase, with prices consistently declining. The price opens lower on a particular day which reflects the downtrend. However, as the session progresses, buyers step in and push the price back up, eventually closing near the opening level. This results in a candlestick with a small real body and a long lower shadow, resembling a hammer shape.

The long shadow at the bottom shows that sellers initially pushed the price down, but then buyers took control and pushed it back up. This suggests that the bearish momentum might be decreasing. This pattern is seen as a potential signal for a bullish reversal, as it implies that the selling pressure has been absorbed and buyers are regaining control.

There are generally two types of hammer candlestick patterns. This includes the following:

1. Classic Hammer The Classic Hammer is the standard form of the pattern. It has a small real body at the upper end of the trading range and a long lower shadow. This shadow is generally twice the size of the real body or more. This pattern signifies a strong rejection of lower prices by buyers which sets an opportunity for a potential bullish reversal.

2. Inverted Hammer The Inverted Hammer candlestick pattern is a different type of Hammer pattern. While it shares similarities with the Classic Hammer, it has a long upper shadow instead of a lower shadow. This pattern occurs during a downtrend and can also signal a potential bullish reversal, but with slightly less strength compared to the Classic Hammer.

A hammer candlestick suggests that the selling pressure is losing momentum, and buyers are starting to regain control. This pattern can be an early sign of a potential trend reversal or a pause in the existing downtrend. You should look for the following characteristics to recognize a hammer candlestick pattern.

  • Long Lower Wick: The lower wick/shadow should be at least twice the length of the actual candlestick body. This indicates significant selling pressure during the trading session.

  • Small Real Body: The real body should be relatively small compared to the lower wick as it represents the open and close prices.

  • Formation in a Downtrend: The hammer pattern should be made during a downtrend, as it shows a potential reversal or pause in the existing bearish momentum

Difference between Hammer Candlestick Pattern and Doji Pattern

Both the Hammer and Doji patterns can show that a trend might change, but they have important differences. A Hammer looks like a candlestick with a small body and a long lower shadow. It suggests that after a drop, buyers are stepping in. On the other hand, a Doji has a small body with upper and lower shadows. It means that buyers and sellers are in balance, indicating uncertainty in the market. Let’s explore some key differences between these patterns.

Feature Hammer Candlestick Doji Pattern
Shape
It has a small real body with a long lower shadow.
It has a small or no real body with equal upper and lower shadows.
Implication
Potential bullish reversal.
Indecision or potential reversal (bullish or bearish).
Occurrence
It can occurs after a downtrend.
It can occur in any market condition.

The Hammer Candlestick Pattern is a popular technical analysis tool used by traders to identify potential price reversals in a downtrend. However, it's important to follow certain steps to use this pattern effectively and increase your chances of success.

1. Identify the Pattern Correctly The first step is to ensure that you have correctly identified the Hammer Candlestick Pattern on the price chart. A Hammer Pattern is characterized by a small real body with a long lower shadow, which should be at least twice the length of the real body. Additionally, the Hammer Pattern should appear during a downtrend, which is identified by a series of lower highs and lower lows.

2. Look for Confirmation After identifying the hammer pattern, you should wait for confirmation of the potential reversal. This confirmation comes in the form of the next candlestick, which should close above the closing price of the Hammer Pattern. Many traders choose to enter a long position during the formation of this confirmation candle, as it signals the potential start of an uptrend.

3. Set Stop-Loss and Take-Profit Levels It is important to manage your risk by setting a stop-loss order while trading. A good way to limit losses is by setting a stop-loss just below the lowest point of the Hammer Pattern. If this level is breached, it suggests the downtrend might continue. However, deciding when to take profits is more personal. Since the Hammer Pattern doesn't give clues on where prices might go next, you might need to look at other indicators or resistance levels to figure out good times to take profits.

4. Monitor and Adjust It is also important to monitor the price action closely after entering the trade. If the price moves in your favour, be prepared to exit the position at your predetermined stop-loss level to minimize losses.

Remember, the Hammer Candlestick Pattern is just one tool that helps traders. It is suggested to use the pattern with other technical indicators and risk management strategies.

Benefits and Limitations of Hammer Candlestick Pattern

The hammer candlestick pattern has its advantages and drawbacks, which traders should be aware of before making any trading decisions. The following is the breakdown in table format explaining the benefits and limitations of the hammer candlestick pattern.

Benefits Limitations
It helps to recognise the potential trend reversal from bearish to bullish.
This pattern may generate false signals which leads to incorrect trading decisions.
The hammer candlestick pattern provides entry points for long positions.
It requires confirmation from subsequent candlesticks or additional technical indicators.
It can be used in combination with other technical indicators for added confidence.
The pattern's significance may vary depending on the market context and trading timeframe.
The pattern highlights the presence of buying pressure, even in a downtrend.
The interpretation of this pattern can be subjective, as the pattern's appearance can differ slightly.
Longer shadows indicate stronger reversal potential.
Hammer patterns with small bodies and short shadows may be less reliable.
Higher trading volume during the hammer formation adds credibility to the signal.
The low trading volume during the hammer formation may weaken the reversal signal.

Conclusion

The Hammer Candlestick Pattern provides valuable insights into potential bullish reversals after a downtrend. However, it is important to remember that no single pattern is foolproof, and traders should always consider the broader market context and use additional technical indicators to confirm the signal. Traders can potentially enhance their trading strategies and improve their chances of success BY understanding the aspects of the Hammer Candlestick Pattern and using it effectively.

FAQs on Hammer Candlestick Pattern

Yes, the Hammer Candlestick Pattern is considered a bullish reversal signal, which indicates a potential change in trend from bearish to bullish.

The key difference between a Classic Hammer and an Inverted Hammer is that the classic hammer has a long lower shadow, while the inverted hammer has a long upper shadow.

The next candle closing above the Hammer's closing price confirms this candlestick pattern, which indicates that the bullish momentum is continuing.

Yes, the Hammer Candlestick Pattern can be observed on various time frames, including intraday, daily, weekly, and even monthly charts.

No, the Hammer Candlestick Pattern itself does not provide a specific price target. Traders may need to use additional technical indicators or analysis to determine potential resistance levels.

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