Inverted Hammer Candlestick Pattern Explained Trading Strategy and Backtest Definition & Meaning

Entering the market after the second candle provides a higher risk/reward ratio, where the risk can exceed the ratio dramatically. Hammer and inverted hammer candlestick patterns are a key part of technical trading, forming the building blocks of many strategies. The Hammer pattern, characterized by its small body and long lower shadow, shines as a signal of potential bullish reversal. It tries to indicate that buyers have regained control after sellers pushed the price down, reflecting a shift from a downtrend to an uptrend.

However, during the session, buyers regained control, pushing the price back up near the session’s opening level or even higher, forming a small body at the top. Instead of entering the markets with a long trade after closing of the inverted hammer candle. Traders can wait for one more candle for confirmation of the reversal pattern. Effectively, traders go long once the candle next to pattern candle for additional confirmation. Let’s now look into the market sentiment during the formation of the inverted hammer candle. During the downtrend sellers are in control of the market and continue to lower the prices.

Graphical Characteristics of Patterns

1. Shooting star patterns emerge after a stock rises, suggesting an upper shadow.
2. The inverted hammer is a bullish reversal pattern that signals the trader that a trend reversal is imminent.
3. Multiple candlestick patterns are often confused with the inverted hammer pattern.
4. The pattern is made up of a candle with a small lower body and a long upper wick which is at least two times as large as the short lower body.
5. A Hammer pattern is a single candlestick formation that often signals potential trend reversals within the forex market.

When confidence in an instrument’s direction is lost, new sellers don’t enter, and the result is prices finish higher in the period from where they started. Traders see the lack of selling conviction, and their sentiment toward the instrument changes. Longer-term traders stand aside to see if this new buying pressure has sufficient momentum to change the instrument’s direction. The psychology behind this signal is that the bulls were buying during this time period, but were unable to hold that buying pressure.

What is the inverted hammer pattern?

You could use the average true range indicator to quantify your observation. When it comes to an inverted hammer, the situation is quite the same, but this time, the attempt was to push the price higher. While it failed, market participants did not change their opinion and made other attempts to finally drag the price higher.

1. The lowest point of the hammer pattern is supposed to be the local lowest low.
2. To see why it’s seen as a bullish reversal pattern, we can take a closer look at the potential price action within the session.
3. So far, what we have described is the traditional hammer candlestick.
4. The key feature of Inverted Hammer is that it captures market uncertainty.
5. By using this information the trader can easily prepare a trade plan and execute them accordingly.
6. It would also allow you to have a short enough stop that you could make a decent risk reward on a winning trade.

Inverted Hammer Trading Strategies

This pattern is visually similar to the hammer candlestick but appears at the conclusion of an uptrend, signalling a possible trend reversal in financial markets. It shows that the price is ready to decline after a strong uptrend as the candle has a long lower shadow that depicts the force of bears. Although the pattern is used to open a trade in the opposite direction to the previous trend, the pattern doesn’t indicate what reward you will get. You need other patterns and indicators that will provide a take profit level.

The Inverted Hammer and Shooting Star patterns are often confusing because they look similar but serve totally different purposes and occur in opposite market conditions. Both have a long upper wick and a small real body, but the context within the trend sets them apart. A red inverted hammer is when the close is lower than the open and the body is red (or black). So buyers were able to push the price up during the day but sellers took control and brought the price back down and closed below the open. You could place your stop loss below the low of the candlestick pattern.

Thus the market sentiment changes from bearish to bullish during this candle. The long wick shows that buyers were able to take control of the market and increase the prices. Confirmation (orange) occurred on the next candle, which gapped higher before being bid up to a close far above the hammer’s closing price. If the price is going aggressively upward during the confirmation candle, a stop loss is put below the hammer’s low, or perhaps just below the hammer’s true body.

If this pattern is found at the end of a downtrend, it is generally known as a “hammer“. In summary, both red and green inverted hammer is a reversal but green is more reliable because of the higher close. But whatever the colour, always look at the candle in the bigger picture of market trends, support levels and confirmation signals. An Inverted Hammer always has a small body and a long upper shadow, but it can be either green or red. Green means the price closed up, and red means the price closed down. Candlestick charts have become some of the most popular charting methods for technical traders.

Volume Confirmation

Ayush is a seasoned financial markets expert with over 3years of experience. He has a passion for breaking down complex financial concepts into simple, digestible terms. Through his 50+ articles, Ayush has helped countless individuals navigate the often intimidating world of finance. Trend line – This is an imaginary line you can draw across the highs and lows (peaks and valleys) of prices. Draw the line access the lows for an upward trend and across the highs for a downward trend.

However, a trader can’t be fully sure the bullish trend will occur even after a confirmation candlestick. difference between hammer and inverted hammer There are two examples on one chart that confirms the hammer pattern is one of the most frequent candlestick patterns. A hammer pattern is a candlestick that has a long lower wick and a short body. With little or no upper wick, a hammer candlestick should resemble a hammer. This bullish reversal pattern appears at the end of downtrends, signalling that a bear market may be about to bounce into an uptrend.

It suggests that although buyers initially pushed the price higher, they lost control, allowing sellers to drive prices down significantly by the end of the session. However, during this time, buyers regained some control, leading to the price closing near its opening level. Thomas Bulkowski tested the pattern extensively and concludes on his website that the Hanging Man pattern resolves in bullish continuation 59% of the time. Harami candlesticks indicate loss of momentum and potential reversal after a strong trend. The second candlestick must be contained within the body of the first, though the shadows may protrude slightly.