The inverted hammer pattern in candlestick trading is a reversal pattern from a bearish trend to a bullish trend. The pattern is formed as the price has been moving lower and lower. The shape is that of a hammer held upside down.
The inverted hammer pattern shows up as a single line pattern made of one candle body that can be either green or red. The size of the body is typically small, while the length of the handle is at least twice as long as the body. When it is forming a downtrend, the possibility of a price reversal is increased. This means the price will increase after the pattern is formed.
This pattern happens after a downtrend and happens and usually signals an impending potential price reversal upward, as the result of a bearish trend. We’ll talk here about the inverted hammer pattern, how to identify it, what its characteristics are, how to interpret it, and more.
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Table of Contents
How to Identify the Inverted Hammer Pattern in Candlestick Trading?
Identifying an inverted hammer pattern in candlestick trading is not difficult if you know how to follow candlestick trading. However, you need to know more than just how to spot the pattern. You will need to learn about the construction and the characteristics of the inverted hammer pattern
Construction of Inverted Hammer Pattern
Because the inverted hammer pattern is frequently seen, it attracts a lot of attention and trading. But there is more to it than just spotting the pattern. The pattern happens during a downtrend and will have the following construction:
- Shadow: a long upper shadow or wick with little or no lower shadow or wick. The upper shadow should be at least twice the size of the body of the candle, like an upside-down hammer.
- Body: Small lower body and a wick at least twice as long as the body. The body (head) is made of the open and close prices, and the upper shadow is the amount generated by the increased price. When they happen near key levels of support, this is an even stronger signal.
Key Characteristics of Inverted Hammer Pattern
The inverted hammer pattern starts with a long candle on the first day, and then a small body appears on the second day at the end of the lower range. It is confirmed when the next day, the pattern continues with a confirmation candle with a bigger body that is bullish with higher prices.
An inverted hammer pattern can only be identified once it has formed at the lower end of a downtrend.
- Color – The body can be either bearish (red) or bullish (green).The first candle should be black.
- Upper Shadow – The long upper shadow indicates that the market put up a struggle before the price increase.
- Lower Shadow – The short or no lower shadow shows that the bears tried to resist the higher price.
- Closing Level – If the closing level is above the opening level, showing that the bulls are too strong.
The price action and location of the inverted hammer candle in a trend are important for validation.
How to Interpret Inverted Hammer Pattern?
Because the inverted hammer pattern indicates that buyers are putting pressure on the market, it is a warning that there may be a price reversal after a bearish trend.
Following a downtrend, the atmosphere is bearish, but as the price opens, it trades higher. This means the bulls have taken over but cannot hold their strength yet, bringing the price back down to the lower end. Although the bears are still in control, the bulls take charge again the next day with no resistance.
How to Improve the Reliability of Inverted Hammer Pattern in Candlestick Trading?
One thing to note is that the inverted hammer pattern in candlestick trading is not a signal to buy, but it is a warning of a possible price change. One of the ways to improve reliability is by paying attention to the size of the shadow. Some other tips include:
- The longer the shadow, the better the chances of a bullish breakout.
- If the body is bullish, the inverted hammer pattern is stronger.
- The formation of the inverted hammer has to appear after a downtrend.
- Use the price action and location of the hammer candle to validate the trend.
Trading the Inverted Hammer Pattern with Stops Below the Support Line
Described below are a few things that you should consider when trading the Inverted Hammer pattern with stops below the support line strategy –
Market Environment
The inverted hammer pattern is perfect in a divergent environment. A divergent environment in the market means that something is changing and is prime for a price reversal.
Identify and Confirm Trade Opportunity
When the pattern shows itself, make sure to look for the confirmation candlestick after the inverted hammer pattern. Using the price action and trend, you can confirm that the price change is coming.
Determine Trade Entry, Stop Loss, and Take Profit Levels
There are three important descriptions in trading the inverted hammer pattern you should know.
- The trade entry point or level is the price that you buy or sell. It is a component of a previously set trading strategy to minimize risks and emotions.
- The stop loss level or order is essential in trading the inverted hammer pattern. This is the point at which your broker has been ordered to sell a stock when it hits a certain price. It limits your loss and risk. The investor typically finds the most recent support level of stock and puts the stop loss just under that amount.
- A take profit level or order is the opposite of the stop loss level or order. This is the amount your broker closes on when a specific profit level is reached.
Execute and Manage Trade
If the next day the market opens above the body, you should consider selling and do not wait for the take profit or stop loss to hit. If you notice a hanging man formation, this indicates that the inverted hammer will end bearish, and this could be a problem.
Advantages and Limitations of Trading Inverted Hammer Patterns
Now that we have covered the basics, let us also review a few advantages and limitations of trading the Inverted Hammer pattern. When integrating this pattern into your trading strategy, it is important to consider these advantages and limitations.
Advantages of Trading Inverted Hammer Patterns
Listed below are the primary advantages of trading the Inverted Hammer pattern –
- When the inverted hammer candle triggers a new uptrend, you are able to enter the market at the beginning of a trend to get the benefit of the full upward movement
- This pattern is easy to identify on any chart
Limitations of Trading Inverted Hammer Patterns
Listed below are the primary limitations of trading the Inverted Hammer pattern –
- The pattern may be a momentary surge in bullish price action that does not go on to develop a long-term trend reversal
- Because the inverted hammer pattern is just one candle, if you rely too much on just this candle without waiting for confirmation, you can have a bad outcome
Candlestick Pattern Opposite to Inverted Hammer Pattern
The hanging man candlestick pattern is the opposite of the hammer pattern. The hanging man is bearish instead of bullish. Both of these candlestick patterns have the same shape, but the hanging man forms at the end of an uptrend rather than at the end of a downtrend.
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Conclusion
To wrap things up, an inverted hammer candlestick pattern is a single line pattern made of one candle body that can be either green or red. The size of the body is typically small, while the length of the handle is at least twice as long as the body. Some of the indicators to look for include:
- It is at the end of a downtrend
- It can be bearish or bullish
- The first candle has to be black
- The shadow of wick above the body should be at least twice as long as the body
- There should be little or no shadow or wick below the body
In addition, you should always wait for the next candle to confirm the inverted hammer pattern trend. This is how traders get a clue of whether the prices will go higher or lower. Also, make sure to have your stop loss and take profit levels set before doing anything.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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