When using technical analysis, many traders use candlesticks to determine potential reversals or continuation moves. One of the most common is a “hammer candlestick,” used to determine possible bullish reversals in financial markets. It is one of the most widely recognizable candlesticks, therefore attracting the attention of a lot of traders.
What Is a Hammer Candlestick?
A hammer candlestick is a candlestick that shows a significant attempt to drop in value, only to turn around and show signs of strength. The hammer typically suggests that the buyers will overrun the sellers and is often used as a signal to get long of a market.
That being said, other hammers can mean different things. However, the pure “hammer candlestick” is a sign that exhaustion is starting to set into a downward trend.
What Does the Hammer Candlestick Look Like?
A typical hammer candlestick on the AMSTERDAX platform.
A Hammer Candlestick looks like a hammer in the sense that there is a small body with a long handle underneath. It is considered a reversal signal, as it is a reaction to sellers losing power.
The market has been selling off when it is formed, only to create a candlestick with a long shadow underneath it, suggesting that the buyers have started to push back. The candlestick has a long shadow, also referred to as the “handle,” and the head of the hammer, which should be thought of as a head like a mallet. Below are a few examples. It should be noted that whether the hammer is green or red does not matter much, but the longer the shadow or wick, the better the signal because it shows an extreme reaction.
- Green Hammer – The green hammer is simply a hammer with a green head or mallet. It has a long shadow underneath, only to see the market turnaround and close slightly positive for that period.
- Red Hammer – The red hammer is the same as the green hammer but closes slightly negative for the period.
- Long Lower Shadow – The long lower shadow candlestick is a candlestick with an extraordinarily long wick underneath it.
Bullish Hammer
The most common type of hammer is going to be the bullish hammer, which forms after a pullback in the market. The candlestick formed is a sign that sellers had tried to push the markets much lower but were repudiated. A break above the top of the bullish hammer during the next candlestick is considered a relatively strong sign that the market’s movement has shifted to the upside.
A bullish hammer, showing sellers running out of momentum. Notice how it is red, but the market rallied after it – demonstrated on the AMSTERDAX platform.
Bearish Hammer (Hanging Man)
A Bearish Hammer, also known as a “Hanging Man,” is the same shape but forms higher at the top of a move. The idea is that during that candle, sellers came in and pushed the market down, only to see buyers come in and push back. However, seeing a lower low during the next candlestick can signify that the buyers are starting to run out of momentum.
After all, it showed resiliency to push the candlestick back to the upside, so suddenly losing that momentum is not a good sign for bullish traders. It is not entirely uncommon for a “Hanging Man” to form at the top of an uptrend.
Not only is this “Hanging Man” at the top of an uptrend, but there are also two in a row…showing real weakness. AMSTERDAX platform.
What is an Inverted Hammer Candlestick?
An inverted Hammer is the same shape as a typical hammer but is upside down. There is a long shadow to the upside, followed by a body with little height. It’s a sign that the buyers came and pushed the market higher, but the sellers pushed back down.
An inverted hammer on the AMSTERDAX platform.
Inverted Hammer Bullish
The Inverted Hammer can be bullish because it can form lower at the bottom of a move. Think of it this way: the market has been in a downtrend for quite some time, and then during this particular candlestick, buyers came in to push the market to the upside, only to be repudiated by the sellers.
However, what happens if the buyers break the top of that inverted hammer during the next candle? About what that says, it shows that bullish traders have had absolute resiliency to push to the upside. Traders that had shorted the market are now starting to lose money, causing them to come in and repurchase positions, putting more of an upward squeeze in the market.
Bullish inverted hammer on the AMSTERDAX platform. It is only bullish once the market breaks above it. It shows that sellers are losing money.
Bearish Inverted Hammer (Shooting Star)
One of the most widely followed bearish signals is an inverted Hammer known as a “Shooting Star.” This inverted hammer forms at the top of a move to the upside and shows that the sellers have come in and started pushing lower. Doing so indicates exhaustion to the upside and that the buyers may run out of power. A breakdown below the bottom of the candlestick during the next candle suggests that more and more traders are losing money on the long side and will sell their positions to control losses.
Inverted hammer – “Shooting star” on the AMSTERDAX platform.
How is a Hammer Candlestick Formed?
A hammer candlestick is formed by a market dropping significantly, only to turn around and close either unchanged or relatively unchanged. This candlestick shows that there has been a significant push lower but repudiated by those willing to step in and pick up the market. The result is a candlestick that looks like a hammer or mallet.
In this scenario, you could have a situation where the buyers are starting to overwhelm the sellers, and eventually, the market will continue to rally. In that situation, it becomes a bit of a feedback loop, as those who are short of the market lose money, meaning they have to buy back the position, putting even more upward pressure on the market.
What does the Hammer Candlestick Pattern tell you?
A hammer candlestick pattern tells you that sellers are starting to lose power, and buyers are starting to step in. At the very least, it means that the sellers are at least trying to make a profit. In other words, we will likely see the market either stabilize or turn around.
While the candlestick suggests that the market could go higher, it doesn’t necessarily guarantee it. Like anything else in technical analysis, it merely shows that the probabilities favor a price rise. To help mitigate some false breakouts, some traders will wait until the top of the hammer gets broken during the next candlestick.
Furthermore, hammer candlesticks are usually simply part of a more extensive system, including Fibonacci, support and resistance, moving averages, and many other possibilities.
How to use Hammer Candlestick? Trading Strategies and Examples
While there are virtually limitless ways to use hammer candlesticks in your trading, there are a few overall trading strategies to people use them in, such as the following:
Moving Average and Hammer
As with many other candlestick patterns, formations, and technical indicators, traders often use moving averages to confirm a potential trade. When it comes to using the hammer, a hammer that forms at a widely followed moving average can attract a lot of attention, especially when thinking about the 200-Day moving average, the 100-Day moving average or even the 50-Day moving average.
You can use any moving average that you find helpful. Still, those of the most common ones used by longer-term swing traders, and therefore the idea is that the hammer forming after a pullback on one of those moving averages should attract a certain amount of attention. Traders will enter on a break above the top of that candlestick, placing a stop loss below it.
More about Moving AverageFibonacci Retracements and Hammer
Many traders use Fibonacci retracements, so it does make sense that a hammer that forms at a significant retracement level can attract a lot of attention. For example, the 50% Fibonacci level is widely followed, just as the 61.8% level is. A hammer at either one of these levels after a pullback or retracement can be an excellent signal in the future.
The entry is the same as the other hammer-related strategies; you enter on a hammer break, with the stop loss on the other side of the hammer itself.
Hammer at the 0.618 Fibonnaci retracement level. AMSTERDAX platform.
Big Figure and Hammer
Traders love big round numbers. Numbers 1.00, $50, and 2.5000 are juicy targets. A hammer formed at one of these figures suggests holding. You can look at a hammer that has failed in these areas as a sign that the momentum continues in the opposite direction.
The idea is that enough people are paying attention to that significant number that there is a certain amount of self-fulfilling prophecy at work.
Hammer at $22 on the AMSTERDAX platform.
The Pros and Cons of a Hammer Candlestick
Before you use anything in your trading, it is essential to understand the pros and cons of that candlestick formation, technical indicator, trading system, etc. Because of this, you should keep a few things in mind about hammer candlesticks.
Pros
- Hammer candlesticks are easily identifiable
- Traders tend to pay close attention to them
- Can cause concern for traders on the other side of the trade
Cons
- Not 100% accurate
- Can form due to external forces such as markets closing, instead of any real change in attitude
- Novice traders tend to treat them like “The Holy Grail.”
What is the Limitation of Hammer Candlesticks
Hammer candlesticks are potent signals at times but aren’t necessarily more predictive than anything else. A hammer candlestick needs to be taken into context of what’s happening around them. If the market is closing for the weekend, a hammer candlestick on a one-hour chart might reflect people exiting the market.
Many new traders will look at a hammer as being predictive instead of it being reactive. Hammer candlesticks are much more effective in areas of general support or resistance because it means that the support or resistance is, in fact, holding. In other words, a hammer can confirm what is already suspected in the market.
Time frames matter. Remember that a hammer candlestick on a 15-minute chart can mean something, but more often than not, it won’t mean that much. A hammer candlestick on a weekly chart is much more impressive, as it takes quite a bit more in the way of price action and volume to form that candlestick.
What does a hammer candle mean in trading?
A hammer suggests that perhaps the buyers are getting ready to step into the market to elevate prices.
Is a hammer bullish or bearish?
A hammer is a bullish reversal. However, other candlesticks, such as inverted hammers and bearish inverted hammers, also called shooting stars, can mean different things, depending on the context.
How reliable is a hammer candlestick?
As with all other technical analyses, it merely suggests what probabilities are starting to tell you. If used with other technical studies, it can become very reliable.
Does the color of the hammer candle matter?
It often comes down to where the candlestick forms instead of the color. That being said, a bullish hammer with a small green body suggests a little more power than one with a small red body.
