Technical analysis is a commonly used approach in the financial markets. It involves studying historical price data and patterns to make informed trading decisions. Among the various tools and formations employed in technical analysis, the hammer candlestick pattern stands out as a powerful indicator. This article will delve into the meaning of the hammer candlestick pattern and explain how traders can interpret it when trading.

What Is a Hammer Candle?

A hammer is a specific price formation that is found in trading charts, and it indicates a potential trend reversal. Traders often use the bullish hammer candlestick pattern as a signal for possible trend changes, making it a valuable tool in technical analysis. It occurs at the end of a downtrend and acts as a bullish reversal setup.

How to Spot a Hammer on a Chart

Identifying a hammer formation on a chart can be done by following these key steps:

• Look for a significant downward movement: Begin by searching for a notable decline in the price of the financial instrument.
• Observe the candle shape: The setup is characterised by a small real body near the top of the candle and a long lower shadow. The lower shadow must be at least two times the length of the real body. The colour of the candle doesn’t matter.
• Analyse the context: Traders usually look for areas of support nearby as they may increase the setup's reliability.

How to Trade with a Hammer

Here are some steps traders may want to consider when trading with a hammer on the FXOpen platform:

• Confirm the validity of the hammer: Ensure that the hammer meets the criteria discussed earlier, such as a significant market decline followed by a candle with a small real body near the top and a large lower wick.
• Determine the entry point: Once the hammer setup is confirmed, identify an appropriate entry point for your trade. You may consider waiting for the subsequent bar to close bullish and then enter the trade if the market moves higher, indicating bullish momentum and a potential reversal.
• Set stop-loss and take-profit levels: You may place a stop-loss order below the low of the hammer to protect against potential downside risks. Determine a suitable take-profit level based on your trading strategy, such as a resistance or predefined profit target.
  

How to Use a Hammer Candlestick: An Example

A trader spots a hammer on the hourly chart of the EURUSD pair on the TickTrader platform. They wait for the next candle to close above the hammer to enter the market. Their stop loss is below the setup, with the take profit at the resistance level.

Hammer and Other Chart Patterns

Let’s compare the hammer to other candle formations you may spot on charts.

Hammer vs Inverted Hammer

The inverted hammer is similar to the hammer but appears after an uptrend. It is characterised by a small body near the bottom of the candle and a long upper wick, resembling an inverted hammer. The inverted hammer signals potential bearish reversal, as sellers start to gain strength and push the market down. The long upper wick represents the rejection of higher prices, suggesting a shift in market sentiment from bullish to bearish.

Hammer vs Doji

In contrast to the red or green hammer candlestick pattern, the doji features a small real body with almost equal or close opening and closing prices and long upper and lower wicks. It represents market indecision, where neither buyers nor sellers have gained a clear advantage. While the hammer is potent during the downtrend, the doji can occur after both uptrends and downtrends, and it signals market consolidation or a potential trend reversal.

Hammer vs Shooting Star

In contrast to the hammer, the shooting star formation emerges at the top of an uptrend and suggests a potential bearish reversal. It is identified by a small real body near the bottom of the candle and a long upper wick, implying a rejection of higher prices and potential exhaustion of buying pressure.

Hammer vs Hanging Man

The hanging man emerges after an uptrend and suggests a potential bearish reversal. It resembles the hammer with a small real body near the top and a long lower wick, but the crucial difference is that it occurs in an uptrend. The hanging man implies that sellers are starting to exert influence, potentially leading to a reversal in the market.

The Bottom Line

Successful implementation of the hammer requires experience, practice, and the use of additional technical analysis tools and indicators. Traders never rely solely on the hammer formation but integrate it into a comprehensive trading strategy that includes risk management techniques, trend analysis, and support/resistance levels. If you want to apply this formation, you can open an FXOpen account to trade different financial instruments.

FAQ

What is a hammer candlestick?

A hammer is a specific setup found in charts that indicates a potential reversal to an uptrend. It is formed when a financial instrument opens at a certain price, experiences a significant decline during the trading period, but eventually rallies back and closes near its opening price.

Is a hammer candlestick pattern bullish?

Yes, the hammer candlestick pattern is generally considered bullish. It signifies a potential trend reversal after a downtrend, as buyers enter the market and drive the price higher from its lows. The long lower shadow of the hammer indicates that the buying pressure is strong and can potentially lead to further upward movement in the market.

Hammer vs shooting star

The hammer indicates a potential bullish reversal and appears after a downtrend. It has a small real body, a small or non-existent upper shadow, and a long lower shadow, signifying buying pressure. Conversely, the shooting star suggests a possible bearish reversal and appears at the top of an uptrend. It features a small real body near the bottom and a long upper shadow, indicating selling pressure and the potential exhaustion of buying momentum.

This article represents the opinion of the Companies operating under the FXOpen brand only. It is not to be construed as an offer, solicitation, or recommendation with respect to products and services provided by the Companies operating under the FXOpen brand, nor is it to be considered financial advice.