Table of Content
What is Hammer candlestick pattern?
Traders often use the candlestick patterns as a visual aid in determining the future price movement of the assets in which they are going to trade. A candlestick is nothing but the action of price which means according to the different candles the movement of the market is different that traders want to know so that they could understand the psychology of the market. One of the popular candlestick patterns known as the hammer also works effectively in the price representation of security. It is a single-candle formation, typically indicating the reversal in the downtrend and form on the bottom of a downtrend. It has a small real body with a long lower shadow of at least 70-75% of its overall length and the remaining part ( 20-25% ) contributes to the size of its body. There is no to very short upper shadow. The opening price of this candle is lower than the closing price.
How Hammer candlestick pattern forms?
The hammer candle forms during a downtrend in the market and tries to convey that there could be a potential reversal in the trend. This candle forms when the price opens at a certain level and sellers come in and push the price significantly below that certain level but buyers oppose the seller's action and retake the price even above the opening price and close the candle there. In the case of formation of a small upper shadow, there is a slight decline in the price. this is how the hammer candle formsHow to identify the Hammer candlestick pattern?
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Identifying a proper hammer candlestick pattern could be a little bit easy, few notable characteristics of a hammer help to identify it. Generally a good hammer candle forms at the bottom of the downtrend. The body of this candle is small compared to the lower wick of this candle, typically it is considered a healthy candle if the ratio of body and the lower wick is 1:3 which means the size of the body should constitute the 20-25% part and that of lower wick should be 70-75% of the total size to the overall candle. There could be no to little upper shadow on the top of the body. In appearance it is just like a hammer or " T " shaped hence it is called a hammer candle.
How to trade the Hammer candlestick pattern?
Here are few steps to make trades using hammer candlestick pattern,
1. Search for the hammers that are formed at the bottom of a downtrend to increase its accuracy, because there could be false hammers that can form during the continuation of a downtrend which can mislead to make trades.
2. To estimate the bottom of a downtrend traders should analyze previous support levels and volume confirmation, use momentum indicators in conjunction with other technical indicators to avoid the false hammer and get probably accurate bottoms.
3. Once a hammer is found satisfying all the conditions, traders can make entry right after the formation of the confirmation candle in an uptrend indicating that potential buyers have entered the market, setting the stop-loss at the low of hammer candle and target according to their risk appetite and trading strategy.
Limitations of Hammer Candlestic pattern
1. Traders solely cannot rely on the hammer to make trades, it needs to be used with other technical parameters to make trades using a hammer.2. Many times price actions create false hammers which means hammer in continuation of downtrend that can lead traders to make wrong trades.
3. It doesn't signal the duration of targets which means it doesn't provide us the information about how long the respective reversal could be, even if there is a reversal in trend due to the formation of this candle.
4. In case of low trading volume it cannot provide accurate confirmation about the bottom due to its dependency on other parameters.
Psychology of Hammer candlestick pattern
Hammer is nothing but a visual representation of the battle between the buyers and sellers. Understanding the psychology behind the formation of candles helps traders to understand why trends get reversed due to the formation of the hammer at the bottom of a downtrend. At the stage of initial selling pressure, when the trading period activates sellers dominate the market, leading the price to fall at a significant level which indicates that the price will likely continue in a downward direction but here buyers make their entry in the market thinking that the security is available at a much lower price than its actual price as a result they start aggressive buying and lead the price to rise above the opening price which signals that the market is dominated by buyer's by the end of that trading period, thus hammer candle form.Difference between Hammer, Hanging man and Doji candle
Hammer: Hammer is the trend reversal candle that forms at the bottom of the downtrend, it is a single candlestick pattern, considered important for its bullish nature as it has the potential to convert the downtrend to uptrend. Although it could be green or red in colour but if it is green it is considered more significant.
Hanging man: In appearance, it is just like a hammer candle with all other similar characteristics, it is also considered a trend reversal candle but it revers the uptrend into a downtrend which means it is a bearish reversal candle, it forms on the top of an uptrend, again the colour don't matter here but if it is red, it is more convenient.
Doji Candle: It is also one of the important signals of price action indicating uncertainty in the movement of the market in that trading period. The difference between opening and closing price of this candle is negligible hence there is a very small real body compared to the wick of it. It indicates that during the period of trading session, there was a significant struggle between the buyers and sellers but none of them dominated the market by the end of that session which is a sign of indecision for market participants. It can form on the bottom, top and during the continuation of a trend.
In Closing
Hammer is one of the powerful and popular candlestick pattern, visually represents the sentiment of the market and help to understand the psychology of buyers and sellers struggling during the trading session. There are multiple ways to make trades by using this candle but it is equally important to understand the required situation to grasp the proper candle because there could be a false hammer, to avoid such kind of situation, where it becomes difficult to identify probably accurate hammer, it is necessary to use it with other technical indicators as it has certain limitations. There are also variations of this candle, known as hanging man and doji which play different roles in different kinds of situations.
Need to Know
1. Can a Hammer Candle be bearish?Generally, a hammer is bullish but there is variation of this candle called hanging man which acts as a bearish candle.
2. How reliable is the hammer candlestick pattern?
The reliability of the hammer candlestick like other technical indicators, depends upon multiple factors such as the market conditions and specific assets in which it is being traded. The reliability is around 60-70% if it is used properly with the combination of other technical indicators and a good strategy.
3. How do I combine the hammer with other indicators?
To use a hammer in combination with other technical indicators, first find the hammer at the bottom of a downtrend and then confirm the bottom with previous support and resistance levels with volume to get an idea about the number of market participants also use MACD to trend analysis with RSI to identify the oversold and overbought conditions. Additionally, use Fibonacci retracement points to validate the signal. The process of using a hammer with a multi-indicator approach can increase the reliability of this candle.
4. What are the common mistakes traders make while using hammer candlestick patterns?
Often traders do not look for the supportive parameters of the hammer such as important support levels, indicators, volume and even don't wait for the confirmation candle due to fear of missing out on some moves in the market.
