Inverted hammer: what is it and how to identify it in trading

Skilling Writers Team
2023-03-10
- Trading
- Education

What is the hammer and inverted hammer candlestick pattern?

Candlestick charts represent price movements for a specific time period and consist of candle-like shapes. Each candlestick displays four key pieces of information: the opening price, the closing price, the high price, and the low price.

Hammer

The hammer is formed by a candle with a small body and a long lower shadow. This means that sellers dominated the market during the trading session, pushing the price down, but buyers have managed to reverse the trend and push the price back up, causing the candle to close near the day's highs.

Inverted hammer

The inverted hammer or sometimes called an upside down hammer and it implies a potential bottom reversal. On the other hand, is formed by a candle with a small body and a long upper shadow. Meaning that buyers dominated the market during the trading session, pushing the price up, but sellers have managed to reverse the trend and push the price back down, causing the candle to close near the day's lows.

When a hammer is identified after a prolonged downtrend, it may indicate that the market has reached a bottom and is likely to reverse to an uptrend. Similarly, when an inverted hammer pattern is identified after a prolonged uptrend, it may indicate that the market has reached a top and is likely to reverse to a downtrend.

How to identify an inverted hammer and what patterns does it follow?

To identify an Inverted Hammer pattern, traders should look for the following characteristics:

The candle has a small real body at the bottom of the range.
The upper shadow is long and represents the high of the day.
The lower shadow is non-existent or very small.
The pattern appears after a prolonged uptrend.

The Inverted Hammer pattern follows a specific pattern of price action. After a prolonged uptrend, the market opens higher, but sellers step in and push prices down. However, buyers return, and the market closes near the opening price. This indicates that sellers have not been able to maintain control, and buyers may be ready to push prices higher again.

Traders should be cautious when interpreting the inverted hammer pattern as it may not always indicate a reversal in the market. It is important to consider other technical indicators and analyze the overall market trend before making any trading decisions based on a single candlestick pattern.

Other chart patterns traders should be aware of

There are many other candlestick chart patterns that traders should be aware of. These patterns can provide important insights into market trends and potential price movements.

Some of the most important are:

Doji

A candlestick with a small body and almost no upper or lower shadow. This pattern indicates that buyers and sellers are evenly matched and there is indecision in the market.

Engulfing pattern

It occurs when a large bullish or bearish candlestick completely engulfs the previous candlestick. This pattern suggests a potential reversal in the market.

Piercing line pattern

It’s characterized by a long candlestick followed by a long green candlestick that opens below the previous day's closing price. This suggests a potential reversal in the market as buyers are starting to gain control after a period of selling pressure.

Harami pattern

It’s characterized by a small candlestick inside a larger candlestick. This is another indication of a potential reversal in the market.

Dark cloud cover pattern

It occurs when a long green candlestick is followed by a long candlestick that opens above the previous day's closing price. This pattern suggests a potential reversal in the market as sellers are starting to gain control after a period of buying pressure.

Overall, understanding various chart patterns is important for traders as it can help them identify potential trading opportunities and make informed trading decisions.

Examples of inverted charts in specific instruments

Inverted hammer patterns can be found in various financial instruments, including forex currency pairs, indices and so on. Here are some examples:

The DJ 30 chart shows an inverted hammer which is a technical indicator that suggests a bearish reversal in the stock market. An inverted hammer occurs when the price of security closes lower than its opening and has a long upper shadow (the line between the body and high price). This indicates that sellers controlled trading during the period, pushing prices down from their highs, but that buyers stepped in at the close and prevented a further decline.

This is an example of a bullish reversal signalled by an inverted hammer candlestick pattern. In this case, the EURUSD price increased in the following period, confirming that the inverted hammer was signalling a bullish reversal. This indicates that investors are gaining confidence and buying into the market, ultimately pushing prices higher. The confirmation candle confirms the reversal and suggests that prices will continue to rise.

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Why understanding candlestick charts is important

Knowing candlestick charts and their patterns is important for traders as it can provide valuable insights into market trends and potential price movements.

By analyzing them, traders can identify patterns that indicate bullish or bearish sentiment in the market, allowing them to make informed trading decisions. The hammer and inverted hammer patterns can indicate potential reversal points in the market, while the engulfing pattern can suggest a change in trend direction.

Furthermore, candlestick charts can provide traders with important information about market sentiment and volatility. Long-tailed candlesticks indicate that there was a significant price movement during the trading session, while doji candlesticks suggest that there was indecision in the market.

Understanding them and their patterns can also help traders develop trading strategies and improve their risk management. Traders can use stop-loss orders based on candlestick patterns to limit potential losses and protect potential profits.

Overall, they are valuable tools for traders to analyze market trends, identify potential trading opportunities, and make informed trading decisions. By incorporating candlestick chart analysis into their trading strategies, traders can increase their chances of success in the financial markets.

Not investment advice. Past performance does not guarantee or predict future performance.