Introduction
The Hammer is a commonly observed single candlestick pattern that typically appears during a downtrend and near a strong level of support, whether it be horizontal or diagonal. This pattern is characterized by a candlestick that has a long lower shadow that is two to three times longer than the body. It is worth noting that some sources may allow for a small upper wick to be present in the pattern as well.
While the Hammer pattern can occur as a standalone pattern, it can also form as a part of other candlestick patterns such as the Bullish Engulfing pattern, the Tweezers Bottom pattern, and the Morning Star pattern. When the Hammer appears as a part of these patterns, it usually serves as the second or third candlestick in the pattern.
It is important to note that the height of the Hammer’s lower shadow should not exceed more than three times the height of the body. If the lower shadow does exceed this length, then the pattern may be considered a Dragonfly Doji instead. Essentially, the Dragonfly Doji pattern is very similar to the Hammer, but it has an exceptionally long lower shadow.
The Hammer pattern suggests a potential bullish reversal in the market, as it shows that the selling pressure has been exhausted, and buyers are starting to enter the market. The long lower shadow indicates that sellers were pushing the price down significantly, but buyers were able to step in and push the price back up to close near the open. This indicates that buyers are gaining control over the market, and the trend may reverse from a downtrend to an uptrend.
Traders often look for confirmation in the form of high volume accompanying the Hammer pattern to increase the reliability of the pattern. Additionally, traders may wait for further confirmation of a trend reversal, such as a break of a trendline or a subsequent candlestick pattern indicating bullish sentiment.
How to Identify Perfect Hammer:-
To identify a Hammer candlestick pattern, it is important to follow specific criteria that capture the psychology of the market. The following steps can guide traders in identifying a Hammer pattern:
Step 1: Look for a Downtrend
The first step to identifying a hammer pattern is to look for a downtrend in the specific time frame or session. This can be done by observing the price action and trend lines. It is essential to note that the hammer pattern appears at the end of a downtrend. Therefore, it is crucial to analyze the price action carefully to identify the trend accurately.
Step 2: Identify the Hammer Pattern
The second step in identifying the hammer pattern is to look for a candlestick with a small body, a long lower shadow, and little or no upper shadow. The opening price should be at or near the high of the candlestick, and the closing price should be at or near the open of the candlestick.
The long lower shadow indicates that the bears were in control early in the trading session but lost momentum, and the bulls took over to push the price higher. This strong bullish momentum is a significant indication that a bullish trend reversal may be imminent.
Step 3: Confirm the Hammer Pattern with Volume
The next step is to confirm the hammer pattern with volume. A high trading volume during the formation of the pattern indicates strong market sentiment and confirms the validity of the pattern.
Traders should look for high trading volume during the formation of the hammer pattern to ensure its reliability. If the volume is low, the pattern may not be reliable, and traders should be cautious in their trading decisions.
Step 4: Analyze the Market Environment
The fourth step is to analyze the market environment to determine the potential impact of the hammer pattern on the market. Traders should look for other technical indicators and tools to confirm the validity of the pattern and assess the overall market sentiment.
If the market environment is favorable, traders can use the hammer pattern to make informed trading decisions and take advantage of potential price movements. However, if the market environment is not favorable, traders should be cautious and consider other technical indicators before making any trading decisions.
Step 5: Check for Gaps
The final step is to check for gaps. There should be no gaps between the opening and closing prices of the candlestick, indicating a strong bullish trend. This means that the hammer pattern has been formed.
The presence of gaps is an essential factor in confirming the validity of the hammer pattern. If there is a gap between the opening and closing prices of the candlestick, the pattern may not be reliable, and traders should be cautious in their trading decisions.
Psychology Behind Hammer Pattern:-
The following points summarize the psychology behind the Hammer pattern:
- Rejection of lower prices: The Hammer pattern is formed when the market opens and trades lower, but buyers step in and push the price back up to close near or above the opening price. This indicates that buyers have rejected lower prices, which can create a bullish sentiment in the market.
- Strong bullish sentiment: The long lower shadow of the Hammer candlestick represents a strong bullish sentiment, indicating that buyers have taken control of the market and are pushing prices higher.
- Potential reversal signal: The Hammer pattern is often seen as a potential reversal signal, particularly when it appears after a prolonged downtrend. The rejection of lower prices by buyers can signal that the trend is losing momentum and that a reversal may be imminent.
- Buyers stepping in: The Hammer pattern shows that buyers are stepping in and buying at the lower prices, which can indicate that they believe the stock is undervalued and has potential for future growth.
- Confirmation needed: Traders often wait for confirmation of a potential reversal before taking action, as the Hammer pattern can sometimes be a false signal. Confirmation can come in the form of a higher close or a bullish follow-through day.
Trading Setup in Hammer Pattern:-
To trade the Hammer pattern, traders can follow the following steps:
Step 1: Identify a Hammer Pattern
The first step in setting up a hammer trading strategy is to identify the hammer pattern on a price chart. A hammer pattern is characterized by a small body and a long lower shadow, with little or no upper shadow. This pattern indicates a potential reversal in the trend, as the bears were in control at the start of the trading period, but the bulls took control later in the day.
Step 2: Look for a Bottom Reversal
A hammer pattern can appear at the end of a downtrend, indicating a potential reversal in the trend. However, it’s important to look for additional confirmation, such as an increase in volume or other technical indicators.
Step 3: Volume Confirmation
Look for a spike in volume to confirm the strength of the hammer pattern.
Step 4: Entry Point
Once a hammer pattern has been identified, traders can open a long or buy position. Confirmation of the bullish reversal can be indicated by the next day’s candlestick closing above the high of the hammer pattern.
Step 5: Stop-Loss
To minimize potential losses if the market does not follow the expected trend, traders should set a stop-loss order below the low of the hammer pattern. This risk management technique can be used to protect trading capital.
Step 6: Target
Traders can identify possible resistance levels or use trailing stop losses to set a target for the trade. This will help to lock in profits and minimize losses if the trend reverses unexpectedly. Proper position sizing should always be considered to determine the appropriate risk-reward ratio.
