Hammer candlestick pattern
The hammer candlestick pattern is a popular technical analysis tool used by traders to identify potential trend reversals in the market. It is a bullish pattern that forms after a downtrend, and is characterized by a small real body and a long lower shadow. The candlestick looks like a hammer so that’s why it’s called the name.
The long lower wick indicates that there was selling pressure, but the buyers were able to overcome that pressure and close the candle near the open. This suggests that the bulls are starting to take control and that the trend may be about to reverse.
Traders often use the hammer pattern as a signal to buy, as it suggests that the trend may be reversing and the bulls are taking control of the market.
Inverted Hammer candlestick
Like the bullish hammer pattern, the inverted hammer candlestick pattern also provides a potential bullish reversal signal. This form is usually manifested as: a small entity below, a long upper shadow line above the small entity, and a short or almost no lower shadow line. It is named for its shape like an "upside down" hammer.
When this pattern occurs at the bottom of a downtrend, the price is at a low level, then the bulls push the price higher, and then the price is pushed back towards the opening level but finally closes above the opening level. This is often seen as an underlying bullish signal. If buying power continues, prices could then be pushed higher
How to trade using hammer pattern?
A hammer candlestick pattern is considered confirmed when the next candle closes above the closing price of the hammer. This indicates that there is strong buying pressure behind the stock, and that the bears may be losing control. Traders who see a confirmed hammer candlestick pattern may enter long positions or exit short positions. For those taking new long positions, a stop-loss order can be placed below the low of the hammer's shadow.
Take $GOOGL for example, a hammer pattern has formed on 11/04/2022. The next day another green candle breakout the high of the hammer, confirming the probability of reverse signal. Therefore, the hammer can be used as zone of support ($83.7 - $86.6), and the lower end of $83.7 can be used as a stop-loss point.
Pros and Cons
The hammer pattern is considered a strong bullish signal, indicating a potential reversal of a downtrend. It’s easy to spot on a chart, making it a popular choice for technical traders. And can help traders manage their risk by providing a clear stop-loss level below the low of the hammer.
However, like any technical analysis pattern, the hammer pattern is not foolproof and can give false signals. Traders typically need to wait for confirmation of the bullish reversal before entering a trade, which can delay entry and potentially reduce profits. Also the hammer pattern provides limited information about the strength of the bullish reversal, which can make it difficult to determine the optimal entry and exit points for a trade.
