Hammer Candlestick Pattern: Candlestick patterns are a part of technical analysis preferred by traders to understand and predict the future price movement in securities.

Here in this article, we shall discuss the hammer candlestick pattern with its meaning, types and how to set up a trade with the pattern formation.

What is a Hammer Candlestick Pattern?

A hammer is a type of candlestick pattern which helps to understand the probable direction of the price in security. This pattern resembles the structure of a hammer, which is formed at the bottom of a downtrend indicating a price reversal towards the upside.

The hammer pattern is formed when sellers enter the security to push prices lower, but towards the end of the candle, buyers step in and absorb the selling pressure, eventually pushing prices higher.

In the hammer pattern, the closing price of the candle can be above or below the opening price, but it should be of a very small body with a lower shadow of at least two times the height of the body formed in the pattern.

How to Trade a Hammer Candlestick Pattern?

Taking a position in the security by considering a hammer candlestick pattern with a valid entry signifies potential profits in the trade.

Entry:- When the hammer pattern is formed at the end of a downtrend, an entry for a long position can be initiated. 

It is always advisable to confirm the hammer pattern before entering a long position. Once the pattern is confirmed, a long position can be initiated at the closing price of the next candle, which should be above the high of the hammer candlestick pattern formed.

Stoploss:- The stop loss for the position can be placed at the lowest price of the hammer pattern formed. As a part of risk management trading, respecting the logical stop loss is important.

Profit target:- For the long position entered in a hammer pattern, the target can be based on the risk-to-reward ratio. Also, the profit targets can be set to the next resistance levels from the entry of the position.

Chart of HDFC Bank showing Hammer candlestick pattern with its entry and stop loss.

What is an Inverted Hammer Candlestick Pattern?

An inverted hammer is a type of candlestick pattern that is opposite in formation compared to a Hammer candlestick pattern. Here the Body of the candle is at the bottom of the pattern

The pattern formation indicates the selling pressure in the security is absorbed by the buying pressure created by buyers. When the price of a security is trading with a prior downtrend, the formation of a pattern signals trend reversal.

In the inverted hammer pattern, the closing price of the candle can be above or below the opening price. But it should be of a very small body with a higher shadow of at least two times the height of the body formed in the candle pattern.

How to Trade an Inverted Hammer Candlestick Pattern?

Spotting the formation of an inverted hammer pattern defines the trade opportunity of a good risk-to-reward ratio.

Entry:- The pattern formation at the bottom of a downtrend signals a reversal towards the upside in security. Place a long position at the closing price of the next candle to the inverted hammer pattern.

Stop loss:- The stop loss to the long position can be at the lowest price of the inverted hammer pattern. As a part of risk management trading with stop loss and respecting the logical stop loss is important.

Profit Target:- For the long position entered in an inverted hammer, the profit target can be based on the risk-to-reward. Also, the profit targets can be set to the next resistance levels from the entry position.

Chart of Bajaj Finance Ltd showing the formation of an Inverted hammer pattern.

Aspects to Confirm the Pattern

Here are a few criteria to consider for the confirmation of pattern in a hammer and inverted hammer candlesticks.

• The trader should confirm that the shadow of a pattern should be at least two times larger than the body.
• The entry should be confirmed by the next candle with its closing price higher than the pattern formed.
• The prior trend should be a downtrend and higher volumes at the pattern formation indicate a stronger reversal.
• The colour of the candle doesn’t have any impact on pattern formation.

In Closing

Analyzing the price movement of securities with candlestick patterns helps traders to identify better entry opportunities. From the above learnings, employing a hammer pattern helps to build views to trade with better risk management.

It is always preferred to use a hammer candlestick pattern in conjunction with other technical tools for more well-defined views.

Written By Deepak M

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