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Trading With Inverted Hammer Candlestick Pattern Guidance: What Is Inverted Hammer?

Charlie Brooks

Aug 05, 2022 11:45


Traders can employ a variety of techniques and instruments to guarantee that their positions are lucrative. These techniques and tools, which include charts, candlesticks, and graphs, assist traders in analyzing price fluctuations and prevalent patterns. The inverted hammer candlestick pattern is a prominent technical analysis method that both novice and seasoned traders may utilize. It can aid traders in identifying the buying market and providing entry points for trading.

What Is The Inverted Hammer Candlestick?

The inverted hammer is a candlestick pattern that resembles a hammer but is upside down. Despite being inverted, this is still a positive reversal pattern, signaling the end of a downtrend and the likely start of a new bullish trend. The inverted hammer has three components: the body and two shadows (wicks). A genuine body is short and resembles a rectangle with its longer side extended. The upper wick must be at least two times longer than the actual body. However, the lower wick is negligible or nonexistent. The name of this pattern is derived from its similarity to an inverted hammer.



Look for a candlestick with a long higher wick and little or no lower wick to identify an inverted hammer. Once more, the body should be quite brief.


With the inverted hammer, the session opens with buyers reversing the continuing downturn. Then, sellers regain control, pushing the market back down towards the open. In contrast to what occurs in a hammer pattern, this occurs.


Nonetheless, the sellers could only preserve equilibrium. By the conclusion of the session, the market had returned to its initial position, a critical indication that selling momentum is weakening and buyers are prepared to come in.


Similarly to the hammer, an inverted hammer might appear during an upswing. Here, however, it is referred to as a shooting star and signifies an imminent bearish reversal. Our guide to candlestick patterns explains in further detail how shooting stars function.

How Is An Inverted Hammer Constructed?

Hammer happens when the prices of open, low, and closing are roughly equivalent. The formation of an inverted hammer during or after a downturn indicates a highly potential trend reversal. After negative traders have pushed prices down, it emerges when bullish traders are prepared to reverse the downward trend. Observing the upper wick reveals the bulls' efforts to drive the price as high as possible. In contrast, the bears are responsible for the lower wick since they oppose the rising price.


The hammer is a bullish one-day reversal pattern. Its genuine body might be bearish (open is higher than close) or bullish (open is lower than close) (the close is higher than the open). But it doesn't matter how it looks. In any event, it will be considered the bottom of a downturn, and the market line is anticipated to reverse direction.

What Does An Inverted Hammer Indicate to Traders?

A hammer inverted indicates that buyers are exerting pressure on the market and a potential price turnaround following a negative trend. Remember that the inverted hammer candlestick should never be seen in isolation; always validate any potential indications with additional forms or technical indicators. Consult your trading plan before taking action on the inverted hammer.

How to Identify An Inverted Hammer?

The inverted hammer candlestick pattern signifies a bullish or short-term reversal of a downtrend. After a protracted decline, an inverted hammer appears when prices are approaching their lows for the time. It is simple to notice on a chart because it resembles an inverted, hanging shooting star candlestick formation. The body may be either white or black, but often it will be black to indicate the intense purchasing pressure at that price. If the shadow of an inverted hammer is longer than its body, there was more purchasing pressure than selling pressure at that low price.


Therefore, it should only be utilized for technical analyses, not fundamental ones. As with other kinds of technical analysis, traders interpret inverted hammer candlesticks according to a variety of indicators and trading strategies.


A typical inverted variation of this candlestick chart pattern is an example of a probable bullish reversal signal that might lead to higher prices in the near strategy if it emerges after a large price decline. Candlesticks shaped like an inverted hammer may also emerge during periods when the trend's direction is unclear. Based on their position within trending or range market action, significant arguments might be made for both continuation and reversal signals in these instances.

How to Improve The Inverted Hammer's Accuracy

In most circumstances, you should not rely on candlestick patterns such as the inverted hammer as your only entry signal. The majority of traders would agree that a filter or additional condition is required to increase the pattern's success.


In addition, it is essential to employ the inverted hammer in a market and timeframe where it is effective! This is most effectively learned by backtesting.


In this section, we wanted to offer a few past strategies and filters that have produced positive outcomes for us. Numerous live trading strategies employ the aforementioned filters or variants thereof.

1. Seasonality and Time of Day

The market's sensitivity to time is a significant but sometimes disregarded factor. Different patterns and strategies may function differently based on the time of day, weekday, month, or other factors.


When we observe extremely evident trends in our own trading, we capitalize on this. For instance, if we have a gap strategy that performs poorly on Mondays (which has occurred on several occasions), we may exclude Mondays since the weekend gap confuses our signal too much.


Such tendencies exist everywhere, but not with every strategy. You may trade strategies that only go long during one month and a half and short during the other, or that only trade on even or odd days. In addition to that, you must also consider the time of day. For some intraday strategies, a signal that happens at the start of the trading session may be extremely meaningful, but signals that occur throughout the remainder of the day have little value.


Be sure to research the case for your market, as it differs significantly between markets. Again, backtesting is really useful in this regard.

2. Volatility

Taking volatility into consideration is an additional effective method for excluding poor transactions. A strategy or pattern may function quite differently depending on whether it was implemented in an environment of low or high volatility!


In the upcoming strategy examples, we will discuss an indication that has the ability to significantly improve a strategy.


Observing the range of the bars is a simple method for determining the market's volatility, though. The market is quite turbulent if you have tall, sturdy candlesticks with lengthy wicks. Obviously, the reverse is true for a tranquil market. The average true range indicator might be used to quantify your observation.


It may be much easier to identify the patterns you seek in a tumultuous market than in a market with less volatility. The markets are highly unpredictable, and when volatility is factored in, the large swings might generate a pattern out of randomness.


While the above logic appears solid, you will discover that both low volatility and high volatility may be effective. Again, it's all about discovering what works best with your market!

3. The Overall Market Trend

When seen at higher chart resolutions, reversal patterns such as the inverted hammer may appear to occur near the bottom of the range but are really at the top of the trend.


For instance, an inverted hammer occurring after a downtrend on a 60-minute chart may appear to meet all criteria but be part of a larger trend on 240-minute bars.


If you are dealing with low-resolution charts, it may also be beneficial to monitor the price on charts with greater resolutions.


Generally, the longer the span, the greater the tendency. Consequently, if the market is heading upwards on the 240-minute chart but downwards on the 5-minute chart, an inverted hammer will likely have a larger chance of success. The trend in the upper period indicates that the market will soon be heading higher, and as a result, the retreat in the lower timeframe has ended.

The Pros and Cons of An Inverted Hammer Candlestick

Pros

If the inverted hammer candle immediately initiates a new uptrend, traders can join the market at the start of the trend and gain on the whole upward advance.


On a chart, the Inverted Hammer Candlestick is straightforward to recognize.

Cons

The Inverted Hammer is a single candle that represents price activity. Without analyzing further supporting evidence/indicators, relying solely on a single candle to reverse market momentum might lead to suboptimal results.


Momentary reversal: The Inverted Hammer Candle may indicate a brief increase in positive price activity that fails to develop into a longer-term trend reversal. This can occur if purchasers are unable to maintain purchasing pressure in the face of a prevailing downward trend.


Although the period after the discovery of an inverted hammer candlestick may result in a price reversal to the upside, there is no assurance that this trend will persist for lengthy lengths of time. If purchasers cannot maintain their market dominance, the security price may see another downward trend.


Offers A Limited Perspective On Market Behavior: Inverted hammer patterns are only one of a number of candlestick patterns used to anticipate market behavior, among a wide range of measures. Without examining other indications and current situations, relying only on them may result in unfavorable consequences.

Differences Between An Inverted Hammer And A Shooting Star

These two candles have identical shapes. A truly short body consists of a lengthy top wick and a minute bottom wick (or no lower wick at all). Both might be viewed as potential trend-reversal indicators. However, the only difference between them is their position on the chart.


The inverted hammer is always the ultimate indicator of a decline. In contrast, the shooting star emerges at the peak of the trend and indicates a potential decline in price. Essentially, these two patterns have a similar form; however, they send various indications to traders.

Inverted Hammer Trading Strategies

Due to the fact that the inverted hammer cannot be regarded as a conclusive signal, it combines nicely with a number of standard technical analysis patterns.

Double Bottom

Double Bottom is, in fact, one of the most strong reversal patterns. Its form resembles the letter "W" because it consists of two continuous, almost equal low points separated by a modest peak.



This chart's inverted hammer at the second bottom verifies the Double Bottom, and both signs indicate an upward trend in the market. A trader must wait for the market to close above the inverted hammer's high to go long.

V-Bottom

This is another pattern of technical analysis named after a letter. Its form resembles the letter V, and it emerges when the price momentum shifts from aggressive selling to aggressive purchasing.


Typically, the inverted hammer occurs before a trader enters the market. When the market closes above the peak of the inverted hammer, it is time to buy. Remember that it is vital to trade both of these patterns with a support level since the price tends to retrace the trend.



Obviously, there are further trading applications for the inverted hammer. For example, traders can profit from pullbacks during an upswing, and the inverted hammer in this scenario signals a probable entry on a retreat.


Relative Strength Index (RSI) and Inverted Hammer Candlestick Pattern

The RSI is a well-known trend reversal indicator that identifies regions of oversupply or overdemand and may signal a likely trend reversal. This indicator is often available on all charting applications.


When adding the RSI indicator to your charting platforms, you'll be on the lookout for a crossing at the 30 levels and the appearance of the inverted hammer candlestick.


The RSI aids in the identification of trend reversals. The confirmation comes when the candlestick that follows the inverted hammer is finished. Then, a trader will place a position with a stop loss below the lowest price level represented by the inverted hammer candle.

Inverted hammer and ADX filter

The ADX indicators are one of the strongest indicators for evaluating and monitoring volatility. It's one of those tried-and-true techniques that we apply to every strategy in an effort to boost performance.


This indicator will enhance a substantial number of strategies, albeit it is not always effective. Typically, a value greater than 20 indicates a strong trend. Consequently, we will employ this in this strategy.

Consider The Following While Trading Using Inverted Hammer:

When studying stocks using the inverted hammer candlestick pattern, it is important to search for specific characteristics.


Listed below are many factors that may assist you in trading with an inverted hammer candlestick pattern:

1.Validate the pattern:

When entering a trade with an Inverted Hammer candlestick, traders must examine specific confirmation conditions.


The trader must ensure that the top shadow's length exceeds twice the actual body's length.


If the Inverted Hammers formation occurs with a gap below the previous day's candlestick, the likelihood of a reversal increases.


The trading volume should be substantial on the day when the Inverted Hammer candlestick pattern forms. High volume indicates that buyers have joined the market and are putting pressure on the stock price to rise.


If the price opens higher the next day, it is preferable to start a purchasing position the following day.


Before entering the trade, the trader must analyze the conditions mentioned above to validate the Inverted Hammer's bullish reversal signal.

2. The psychological basis of the pattern:

The past trend should be a downtrend, which means prices should be making lower lows, and sellers should impose selling pressure to drive the price down.


When this candlestick appears, it indicates that bulls have returned to the market and are exerting buying pressure to drive prices up, while bears are unable to pull prices down.


A buy position can be initiated if the price sustains its strength during the next trading session.

3. Do not mistake this pattern with other candlestick patterns:

Traders frequently get the inverted hammer and shooting star candlestick patterns confused. However, it is important to notice that the inverted hammer appears after a decline, whereas shooting stars appear after an uptrend.

The Bottom Line

The inverted hammer candlestick pattern is formed when a smaller, uncertain candle follows a huge bearish candle. It indicates that selling pressure has begun to subside, and purchasing pressure is increasing. It is essential while evaluating an inverted hammer candlestick pattern to examine additional market signs, such as price movement over time, general market volatility, volume activity, etc.