In the dynamic world of trading, it is important to understand market signals to make informed decisions. One of the most reliable and widely recognized patterns in technical analysis is the inverted hammer candlestick that helps you understand price action. This powerful pattern can signal a potential reversal in the market, providing traders with valuable information. In this article, we will explore how the inverted hammer candlestick pattern works in trading, what its significance is and how you can incorporate it into your trading strategy, and when the inverted hammer candlestick pattern behaves bullish or bearish.
What is Inverted Hammer Candlestick Patterns?
The Inverted Hammer candlestick pattern is a single candlestick pattern that looks like an inverted hammer with a small body at the bottom of the candle and the upper shadow (candle wick), which is at least 2 times the length of the body, and the lower shadow is very small.
The color of the body (red and green) does not matter much as it is a bullish reversal pattern, so the inverted hammer with green color is given more preference.
What is a Hammer Candlestick Patterns?
The hammer candlestick pattern is a bearish reversal, but both patterns are bullish reversal patterns, meaning that hammer candlesticks are characterized by a small body, a long lower shadow (called a wick), and little or no upper shadow. The small body represents the close and open prices being relatively close, while the long lower shadow indicates that sellers initially pushed the price down but were eventually overwhelmed by buyers, who pushed the price back up.
How Does the Inverted Hammer Candlestick Pattern Work?
The inverted hammer candlestick pattern only works if the previous session was in a downtrend, and only then will it be considered a perfect and reversal inverted hammer. After the formation of this candle, investors and traders expect that the market will reverse from here and move upwards.
The psychology behind this expectation is that the stock remained downtrend for some time, then as soon as the next candle opens, the bulls take the price upwards, which means that the sellers had fully maintained the downtrend, so the bulls became active on this price, but before the candle closes, the sellers take the price of that candle down. Still, this inverted pattern is considered a bullish reversal pattern because the bulls put a little break in the control that the sellers had over the price. In such a situation, one should look for a buying opportunity, but only after getting some confirmation. Because till now the buyers have completely controlled the price.
What Does an Inverted Hammer Indicate?
An inverted hammer indicates that while sellers initially controlled the market, buyers entered aggressively, pushing prices higher. However, the close of the session remained near the opening price, creating a small real body.
This pattern tells traders that the downtrend might be losing steam, and a reversal to the upside could be imminent.
How to Use the Inverted Hammer for Profitable Trades?
Step 1: Confirm the Downtrend
Before acting on an inverted hammer, ensure that the market is in a downtrend. You can use tools like moving averages or trendlines to confirm the trend direction.
Step 2: Look for Supporting Signals
The inverted hammer alone isn’t sufficient to confirm a reversal. Combine it with:
- Volume Analysis: High trading volume during the inverted hammer’s formation adds credibility to the pattern.
- Indicators: Tools like the Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD) can confirm oversold conditions, hinting at a reversal.
Step 3: Wait for Confirmation
The candle following the inverted hammer is crucial. A strong bullish candle (with a close above the inverted hammer’s high) confirms the reversal. This is your cue to enter a long trade.
Step 4: Set Stop-Loss and Target Levels
- Stop-Loss: Place it slightly below the low of the inverted hammer to minimize risk.
- Profit Target: Use resistance levels or Fibonacci retracements to determine your target price.
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