Understanding The Hammer Candlestick Pattern

Traders have used the hammer candlestick pattern for a long time in technical analysis and it helps in the movement of stock prices. It indicates the reversal of trend, specifically from bearish to bullish trend.

The appearance of a hammer is a signal that bears have lost the superior position they hold on the market, and the bulls have taken over it. When a stock is in a downtrend, but then buying has overtaken the selling pressure. Which results in the closing price being near the opening price.

Generally, the body of the candlestick determines the opening and closing prices. While the wick of the candle, or we can say, the shadow represents the highest and the lowest prices between that period.

For a candlestick to occur, the respectable length on the wick should be twice that of the body. Additionally, the price should start moving upward after a successful appearance of a candlestick. Altogether, this is what we call confirmation for an impending bear market.

How to identify a hammer candlestick pattern?

As the name suggests, a hammer candlestick pattern will have a definite appearance of a hammer in the stock chart. It is one of the easiest patterns to notice, and any regular joe can notice its appearance and trade upon it. 

Let us see some of the key features of a candlestick pattern.

• Before the appearance of a hammer candlestick pattern, there should be a clear downtrend with at least two to three bearish candlesticks.

• The candlestick should have a very short body, and a short body is formed if the opening price, the high price, and the closing price are very close to each other.

• The candlestick should have a long downtrend shadow, a shadow that is at least twice the length of the body is acceptable.

• The candlestick should have a short or no upper shadow. A short upper shadow indicates that the closing price is close to the highest price during that period.

From this, we can interpret that when the prices opened lower than the previous price due to greater selling pressure. Eventually, the buying pressure increased, balanced out, and surpassed the selling pressure. Furthermore, when the closing price ends very near to the opening price, it forms a short, clear body for the candle.

What makes candlestick patterns a strong indicator?

We should keep in mind that everyone trading in the market is looking to bring maximum cashback to their home. So it is absolutely necessary to have a strong price indicator before entering a trade.

A candlestick is a strong and reliable indicator of a bullish market when the closing price is above the opening price, or we can say that it is near the highest price in that period.

Furthermore, when the lower shadow is three to four times longer in a hammer candlestick. Then we can say that there is very high buying pressure for that particular stock. We can also interpret the longer lower shadow as the market rejects the lower selling prices and is in a clear buying mood. 

A hammer candlestick that forms in an area of support for the previous price movement is also a strong indicator for a bear market.

Limitations of Hammer Candlestick Pattern

There is no guarantee that the prices will move up even after a confirmation candle. Yes, the hammer candlestick pattern is a definite indicator for an upward trend, but you cannot determine how long the uptrend will last. It can even be for two periods or even longer.

So, traders should not solely depend on the appearance of a hammer candlestick pattern as a positive affirmation for entering a trade. Additionally, traders should watch other indicators and confirm their theories before committing to a trade.

Pro tip: For those who hold long positions, you should place a stop loss at the bottom of the hammer’s shadow.

Conclusion

While the hammer candlestick pattern indicates the bull market, traders should keep an eye and benefit from shorting the stock using the shooting star pattern. As the name suggests, the shooting star pattern indicates the fall in stock price and is just the opposite of hammer.