What Is a Hammer Candlestick?
A hammer is a price pattern in candlestick charting that occurs when a security trades significantly lower than its opening price but rallies by the period’s close to near the opening level. This pattern forms a hammer-shaped candlestick, characterized by a lower shadow at least twice the size of its real body. The candlestick’s body reflects the difference between the opening and closing prices, while the shadow represents the range between high and low prices for the period.
Key Concepts
- Hammer candlesticks typically appear after a price decline, featuring a small real body and a long lower shadow.
- Sellers dominate early in the trading period, pushing prices down, but buyers regain control, driving prices back up by the close.
- The real body’s close should be near the opening price, and the shadow must be at least twice the height of the real body.
- Hammer candlesticks suggest a potential upside price reversal, confirmed if the subsequent candle closes above the hammer’s close.
Understanding Hammer Candlesticks
A hammer emerges after a security’s price declines, hinting that the market is seeking a bottom. This pattern signals potential seller capitulation and a pending reversal in price direction. The price falls post-opening but recovers by the period’s close.
A hammer should resemble a “T,” indicating potential. Without confirmation, however, it does not guarantee a price reversal.
Confirmation occurs if the following candle closes above the hammer’s closing price, ideally showing strong buying interest. Traders generally enter long positions or exit short positions with the confirmation candle. Stop-loss orders can be placed below the hammer’s shadow.
Hammers aren’t typically used alone; they are supported by price or trend analysis or other technical indicators.
Example of Spotting a Hammer Candlestick
Following a price decline, a hammer pattern can signal a possible upward reversal. A confirming candle that gaps higher and sees upward price movement corroborates the reversal.
Traders usually make purchases during the confirmation candle, setting stop-loss orders below the hammer’s shadow or body.
Hammer Candlestick vs. Doji
While a doji also has a small real body, it signals indecision with both upper and lower shadows. It may indicate a reversal or trend continuation depending on subsequent confirmation. Conversely, a hammer, with its long lower shadow, suggests a potential upward reversal after a decline.
Limitations of Hammer Candlesticks
There’s no guarantee that prices will continue to rise post-confirmation candle. The initial hammer and confirmation candle could extend the price significantly, increasing potential entry risk.
Additionally, hammers don’t indicate a specific price target, posing challenges in determining reward potential. Exits often rely on other analysis.
Psychology Behind the Hammer
A hammer generally appears in a downtrend, suggesting that bullish investors are stepping in, possibly reversing the downward trend. The long lower shadow indicates an attempt to continue downsides; however, the final price close contradicts this, suggesting an upward reversal is on the horizon.
Practical Application Tips
Identification and Signal
Ensure the hammer signal appears in a downtrend context. The pattern should show a long lower shadow, twice the real body’s size, and close near the opening price.
Confirmation
Wait for subsequent price movement to confirm the hammer signal. Buy during the formation of the confirmation candle.
Stops and Profits
Use stop-loss orders to protect your trade, typically set below the hammer shadow. Profits can be taken based on other technical indicators like resistance levels or swing lows.
Is a Hammer Candlestick Pattern Bullish?
Yes, it’s a bullish pattern suggesting a price trend reversal. Sellers push prices lower, but buyers regain control, driving prices upward. The reversal is confirmed if the next candle closes above the hammer’s close.
Hammer Candlestick vs. Shooting Star
A hammer candlestick signals a bullish reversal, whereas a shooting star pattern indicates bearish trends. The latter appears after an uptrend, suggesting the price may fall after its initial rise, but it closes at a lower level. It’s essentially the opposite of a hammer.
Bottom Line
A hammer candlestick indicates a possible price reversal following a security’s significant lower trade. Long lower shadows and small bodies mark the pattern, suggesting sellers’ failure to sustain lower prices. This establishes a possible upward reversal, beneficial for making informed trading decisions.
Related Terms: doji, shooting star, confirmation, technical indicators, trend analysis.
