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Hammer and Inverted Hammer Candlestick Patterns

The hammer and the inverted hammer candlestick patterns are among the most popular trading formations. 

 

Both are reversal patterns, and they occur at the bottom of a downtrend. 

 

Structure

 

The hammer pattern is a single-candle bullish reversal pattern that can be spotted at the end of a downtrend. The opening price, close, and top are approximately at the same price, while there is a long wick that extends lower, twice as big as the short body. 

hammer candlestick pattern
 

Irrespective of the colour of the body, both examples in the photo above are hammers. Still, the left candle is considered to be stronger since the close occurs at the top of the candle, signaling strong momentum. 

 

On the other hand, an inverted hammer is exactly what the name itself suggests i.e. a hammer turned upside down. A long shadow shoots higher, while the close, open, and low are all registered near the same level.

inverted hammer candle
 

Similar to a hammer, the green version is more bullish given that there is a higher close. This pattern always occurs at the bottom of a downtrend, signaling an imminent trend change. Again, the wick should be twice as big as the body.

What the hammer formartions tell you

As noted earlier, both of these patterns are considered to be powerful reversal patterns.

Following a downtrend, where the price action created a series of the lower lows and lower highs, the bulls are increasing their presence in the game and are signaling that there might be a change in the price direction. 

 

Thus, a hammer signals a potential change in the price direction, as the bears were unable to follow up on the new short-term low by allowing the bulls to push the price higher to force a higher close. 

 

It is exactly the high close that signals that the bulls have just assumed control over the price action, as they defeated the bears in an important fight near the session lows. 

 

Similarly, the inverted hammer also generates the same message, but in a different manner. The price action opened low, but pushed higher to surprise the bears. Still, the bears still have control and they push back the price action to close near the lows. 

 

Unlike the hammer, the bulls in an inverted hammer were unable to secure a high close, but were defeated in the session’s closing stages. Still, the mere fact that the buyers were able to press the price higher shows that they are testing the bears’ resolve. 

 

The fact that the hammer’s bulls managed to get a close at the top of the candle is the reason the hammer is considered stronger than the inverted hammer. This is a logical sequence as the hammer is considered to be one of the most powerful candlestick patterns of any type. 

 

It is important to note that neither of these two patterns is a direct trading signal, but a tool which generates a sign that the price action may reverse as a balance shift is occurring. 

 

To master the hammer and the inverted hammer, as well as other technical indicators and formations, you may want to consider opening a demo trading account, which you can access here. This way you will prepare yourself before you start risking your own capital.

How to trade the hammer candlestick pattern

As stated earlier, a hammer is a bullish reversal pattern. It occurs at the end of a downtrend when the bears start losing their dominance. In the chart below, we see a GBP/USD daily chart where the price action moves lower up to the point where it prints a fresh short term low.

hammer on a GBP/USD daily chart
 

Although the session opens higher than the recent lows, the bears push the price action lower to secure new lows. However, the bulls surprise them with a press higher to secure the bullish (green) close. At this point, it is clear that the balance has changed in favour of the buyers, and there is a strong likelihood that the trend direction will change. 

 

There are two options available:

  1. Open the trade as soon as the hammer is formed and wait for the potential reversal to start
  2. Wait for the second candle for confirmation. If it’s a bullish (green) candle, enter a trade to capitalize on the reversal.

As an example, we are opting for the first option, although it is a tad riskier. The green horizontal line signals our entry point - where the hammer closed. The red line is the low, against which we place a stop-loss around 10-20 pips beneath. 

 

As a take-profit, you can determine the next resistance to which the bulls are likely to push the price action. In this case, we opted for the previous swing low, which is now the resistance. 

 

Finally, the price action rotates higher in an explosive manner to bank us 300 pips, while we risked around 150 pips. A risk-reward 1:2 is considered to be a very good outcome.

How to trade the inverted hammer pattern

The setup is almost the same as both of these patterns are bullish reversal formations. It is actually almost the same chart, it’s just that this sequence occurred a bit later.

 

Following a bullish reversal, the price action rotates lower again to briefly trade in a downtrend. At one point, the inverted hammer was created as the bulls failed to create a hammer, but still managed to press the price action higher. 


Inverted hammer on GBP/USD daily chart
 

As a result, the next candle exploded higher as the bulls felt that the bears were not so dominant anymore. Hence, the inverted hammer should be seen as a testing field in this case. As soon as the bulls felt the bears’ weakness they reacted quickly to drive the price action and secure a major victory.

 

Trading this formation is very similar to a hammer. A stop-loss should be placed below the most recent swing low. Again, you can either wait for the confirmation candle, or open the trade immediately after the inverted hammer is formed. The profit-taking order(s) should be placed at the previous support and dependent on your risk tolerance. 

 

You can analyze the hammer and inverted hammer patterns, as well as other technical indicators, on the Metatrader 5 trading platform.

Summary

Hammer and inverted hammer are both bullish reversal patterns that take place at the end of a downtrend. The bears, who have been a dominant force so far, are starting to lose their momentum. 

 

As a result, both the hammer and the inverted hammer signal an impending reversal and a change in the trend direction. 

 

It is important to always consult other technical indicators as these patterns are only gauging the market sentiment, and implying that a change in the trend direction may take place soon.

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