A hammer candlestick is a bullish reversal pattern that consists of a small body, a long lower shadow, and little or no upper shadow.
The small body of the candlestick represents the opening and closing prices, while the lower end of the long lower wick represents the bottom price of the stock for a particular time period.
The absence of an upper shadow indicates that the buyers were able to push the price higher, without facing any significant resistance from the sellers.
You can identify a hammer candlestick on a Japanese candlestick chart by looking for a candlestick with a small body and a long lower wick (tail) that is at least twice the size of the body. The absence of an upper shadow is a characteristic of a hammer candlestick. However, in some cases, a small upper shadow may also be present.
Types of Hammer Candlestick
Hammer candlesticks can be either red or green. A red hammer candle indicates the closing price is below the opening, whereas a green hammer candle indicates the closing price is above the opening price.
Green and red variations have their own characteristics and significance. Some of the popular hammer candlestick variants include the inverted hammer, shooting star, and hanging man. You can read the article All 37 Candlestick Chart Patterns in the Stock Market.
The Inverted Hammer
The inverted hammer is a bullish reversal pattern that occurs at the bottom of a downtrend. It has a small body, a long upper shadow, and little or no lower shadow. The inverted hammer pattern suggests that it was eventually dragged back down before the candle closed.
The inverted hammer formation means that the buyers were not able to maintain the momentum, and the sellers may be taking over.
The Shooting Star
The shooting star is a bearish reversal pattern that looks like an inverted hammer but occurs at the top of an uptrend. It has a small body, a long upper shadow, and little or no lower shadow. The shooting star pattern suggests that the buyers were not able to push the price higher, and the sellers may be taking over.
The Hanging Man
The hanging man is a bearish reversal pattern that looks like a hammer but occurs at the top of an uptrend. It has a small body, a long lower shadow, and little or no upper shadow. The hanging man pattern suggests that the buyers were not able to maintain the momentum, and the sellers may be taking over.
Check out – how to trade morning star candlesticks
How to Trade Hammer Candlestick
Hammer candlestick is one the most common candlesticks used for day trading. You can use different trading strategies with hammer candlesticks, including trend reversal, support and resistance, and price action trading.
Trend Reversal Trading Strategy
A hammer candlestick can be used to identify potential trend reversals. If a hammer candlestick occurs at the bottom of a downtrend, it may suggest that the trend is about to reverse, and the price may start moving upwards.
You can enter a long position after the hammer candlestick, with a stop loss below the hammer’s low. The profit target can be set at the next resistance level or based on your risk-reward ratio.
You can use trend reversal trading strategy to invest in Sensex, banknifty or nifty 50.
Support and Resistance Trading
Support and resistance levels are areas where the price tends to stall or reverse. A hammer candlestick that occurs near a significant support level can be used as a buy signal, while a hammer candlestick that occurs near a significant resistance level can be used as a sell signal.
You can enter a long position after the hammer candlestick, with a stop loss below the hammer’s low. The profit target can be set at the next resistance level.
Price Action Trading
Price action is a trading strategy that focuses on analyzing the price movements and patterns on the chart. A hammer candlestick can be used as a signal to enter a long position if it occurs after a downtrend and is followed by a bullish candlestick.
You can enter a long position after the bullish candlestick, with a stop loss below the hammer’s low. The profit target can be set at the next resistance level or based on the trader’s risk-reward ratio. I have explained the steps to use the candlestick for day trading, you can learn about how to do trades using candlestick charts.
Strengths of Hammer Candlestick
Easy to Identify
You can easily identify the Hammer candle in the chart because of its distinct shape with a small body, a long lower shadow, and little to no upper shadow. You can also predict the next candlestick pattern whether it is bullish hammer or bearish shooting star.
Sign of Reversal
Another strength of hammer candlesticks is their ability to signal potential trend reversals. When a hammer candlestick appears at the bottom of a downtrend, it can indicate that the sellers are losing momentum, and the buyers may be taking over, leading to a potential reversal of the trend. This can be a valuable signal to enter the market at the early stages of a trend reversal.
Confirmation with Other Indicators
Hammer candlesticks can be used in conjunction with other technical indicators to confirm a potential trend reversal. For example, you may look for hammer candlesticks in combination with support and resistance levels or moving averages to validate a trading signal.
Weaknesses of Hammer Candlestick
Hammer candlesticks can generate false signals. While a hammer candlestick may indicate a potential trend reversal, it does not guarantee that the trend will indeed reverse. False signals can occur when a hammer candlestick appears in the middle of a trend rather than at the end of it. You may end up entering or exiting the market prematurely.
You require confirmation with other technical indicators or market conditions while using the hammer candlestick. You should not rely solely on hammer candlesticks to make trading decisions but should also consider other technical indicators and fundamental factors.
Not Effective in All Market Conditions
Hammer candlesticks may not be effective in all market conditions, such as during news releases or volatile market conditions. In these situations, the price action may not follow the patterns suggested by hammer candlesticks, leading to false signals and trading losses.
You shouldn’t use the hammer candlestick as the sole basis for making trading decisions. You should use a hammer candlestick in conjunction with other technical indicators and market conditions and wait for confirmation before making any trading decisions.
You can use different trading strategies with hammer candlesticks, including trend reversal, support and resistance, and price action trading. You must enter the trade with a solid trading plan and always use stop-loss orders to manage risk.
I have also shortlisted the best free technical analysis software in India for in-depth analysis of market trends that you can check out.
No, you do not need to have advanced technical analysis knowledge to use hammer candlesticks, but it is recommended to have a basic understanding of candlestick patterns and technical indicators.
Hammer candlesticks are just one of many candlestick patterns used in technical analysis, and their effectiveness depends on various market conditions and other factors.
While hammer candlesticks are primarily used for short-term trading, they can also be used for long-term investing to identify potential entry and exit points.
You can manage risk when trading hammer candlesticks by using stop-loss orders, setting profit targets, and using proper position sizing.
Yes, hammer candlesticks can be used in combination with other technical indicators, such as moving averages, to confirm a trading signal.
You can use hammer candlesticks in your trading strategy to identify potential trend reversals and support and resistance levels, among other things.
A bullish hammer appears at the bottom of a downtrend, indicating a potential reversal, while a bearish hammer appears at the top of an uptrend, indicating a potential reversal.
Yes, hammer candlesticks can be used for short-term trading, such as day trading or options trading.
Yes, hammer candlesticks can be used in all financial markets, including stocks, forex, and commodities.