THE INVERTED CANDLESTICK PATTERN: MAIN TALKING POINTS
The inverted hammer candlestick pattern is commonly observed in the forex market and provides important insight into market momentum. In particular, the inverted hammer can help to validate potential reversals.
The article will outline the following:
- What is the Inverted Hammer?
- Advantages and limitations
- Using the Inverted Hammer Candlestick pattern in trading
- Further reading on trading with candlestick patterns
WHAT IS AN INVERTED HAMMER CANDLESTICK?
The inverted hammer candle has a small real body, an extended upper wick and little or no lower wick. It appears at the bottom of a downtrend and signals a potential bullish reversal. The extended upper wick suggests that the bulls are looking to drive price upwards. Validation of this move will be confirmed or rejected through subsequent price action.
The inverted hammer should not be confused with the shooting star. Both candles have similar appearances but have very different meanings. The shooting star is a bearish signal and appears at the top of an uptrend, while the inverted hammer is a bullish signal at the bottom of a downtrend.
How to spot an Inverted Hammer candlestick pattern:
- Candle with a small real body, a long upper wick and little to no lower wick
- Appears at the bottom of a downtrend
- Stronger signals are produced when the candle appears near key levels of support
What does it indicate:
- Trend reversal to the upside (bullish reversal)
- Rejection of lower prices (sometimes at a key level)
ADVANTAGES AND LIMITATIONS OF THE INVERTED HAMMER CANDLESTICK
Like all candlestick patterns, there are pros and cons to using the inverted hammer in a trading strategy:
- Favorable entry points: If the inverted hammer candle immediately triggers the new uptrend, traders are able to enter the market at the beginning of the trend and capitalize on the full upward movement.
- Easy to Identify: The Inverted Hammer Candlestick is easy to identify on a chart.
- Over-reliance on a single candlestick: The Inverted Hammer is a single candle, representing price action. Relying entirely on a single candle to overturn market momentum, without considering additional supporting evidence/indicators, can result in sub-optimal outcomes.
- Short-lived retracement: The Inverted Hammer Candle may signal a momentary surge in bullish price action that fails to develop into a longer-term trend reversal. This can happen if buyers aren’t able to sustain buying pressure amidst a dominant downward trend.
USING THE INVERTED HAMMER CANDLESTICK PATTERN IN TRADING
Trading the inverted hammer candle involves a lot more than simply identifying the candle. Price actionand the location of the hammer candle, when viewed within the existing trend, are both crucial validating factors for this candlestick.
Trading the Inverted Hammer Candlestick near a Line of Support
Below, is a GBP/USD chart exhibiting a downtrend that consolidates at support. The appearance of the inverted hammer candle near support provides the basis for the bullish reversal. Traders can placestops below the support line to limit downside risk in the event the market moves in the opposite direction.
Targets can be placed at previous levels of resistance that result in a positive risk to reward ratio. Since the inverted hammer candle often signals a reversal in trend, and trends can persist for a long time, traders often identify multiple target levels or simply utilize a trailing stop.
Inverted Hammer Technical Analysis: Fibonacci Retracement
The inverted hammer can also be used to identify retracements in the market. The EUR/USD chart below highlights the inverted hammer (in blue) which signals renewed bullish momentum. TheFibonacci retracement level of 38.2% presents a possible level of support before price regains its upward momentum.
Top traders will look for complementary signals on the chart in order to increase the probability of a successful trade. These will either support or invalidate the trade idea before it is placed. In this example, the appearance of the inverted hammer at the 38.2% level provides a stronger case for the bullish bias as price seems to resist a move lower at this level.