Trading strategy: What is the hammer candlestick pattern?

A Hammer Candlestick pattern forms when a currency pair trades significantly lower than its opening price. The price typically rebounds as the closing price approaches the opening price, signaling a potential bullish reversal in the market.

Key Characteristics and Implications of hammer candlestick

In this pattern, the open, close, and high prices are very close together, creating the distinctive "hammer" appearance.

The lower shadow, or wick, of a Hammer Candlestick is always more than twice the size of the candlestick's body. This pattern usually appears during a downtrend, indicating a possible market reversal.

Open Price: The price at which the currency pair starts trading for the day.
Close Price: The price at which the currency pair finishes trading for the day.
Low Price: The lowest price the currency pair reaches during the day.
High Price: The highest price the currency pair attains throughout the trading day.

For example, if you are trading USD/EUR at 2, with the open price at 1.4, and the market starts declining thereafter, pushing the prices to 1.8, 1.6, and finally 1.5, you will witness a Hammer Candlestick with a long lower wick, depicting a market low for USD/EUR.

Since the close price will come near to the open price, as a trader, you will want to enter the market and buy more USD/EUR positions with an expectation of a market reversal. The reversal will be confirmed on the next candlestick, which will be a bullish candlestick with a higher open price of 1.9. Hereon, the prices of USD/EUR will continue to increase and reach a level equal to or beyond 3, signaling profit-taking opportunities for you.

Types of Hammer Candlesticks

1. Bullish Hammer Candlestick
The Bullish Hammer Candlestick forms during a downtrend and signals potential buying opportunities, indicating a possible bullish reversal. This candlestick features a small body, with little to no upper wick and a significantly long lower wick. The Bullish Hammer suggests that initial selling pressure was stronger than buying pressure, causing the currency pair prices to reach a low point. However, as prices fell, traders began to enter the market by opening buy positions. This shift increased buying pressure, allowing the currency pair price to close higher, thereby signaling a bullish market reversal.

2. Bearish Hammer Candlestick
The Bearish Hammer, also known as the Hanging Man pattern, appears after a prolonged bullish trend in the market. This pattern signals a potential bearish trend reversal, often accompanied by a sudden drop in currency pair prices.

The highest point of the Bearish Hammer indicates an overbought condition in the market, where buying pressure has surpassed selling pressure. This peak prompts traders to exit positions and secure profits, resulting in increased selling pressure. As more traders exit the market, the supply of currency pairs rises, leading to a downtrend characterized by continuous price declines.

3. Bullish Inverted Candlestick
A Bullish Inverted Candlestick is an individual candlestick with a small body and long upper wick. The close price of the currency pair is always above the open price, indicating more significant buying pressures in the market. This candlestick is formed after a long downtrend and signals an uptrend market reversal. With this candlestick, traders can enter buy positions since the market is expected to witness a potential increase in the prices.

4. Bearish Inverted Hammer
The Bearish Inverted Hammer, also known as the Shooting Star pattern, is a single candlestick with a small body and a long upper wick. In this pattern, the opening price of the currency pair is higher than the closing price, indicating that selling pressure has surpassed buying pressure.

This candlestick typically appears after a prolonged uptrend, signaling a potential market reversal to a downtrend. Traders may consider entering a sell position, as the market is expected to experience a significant drop in prices.

Conclusion:

The Hammer candlestick pattern is a powerful indicator of potential market trend reversals. By incorporating it into your reversal strategy, you can effectively identify key buy and sell levels. This pattern typically forms after a downtrend, suggesting that buying pressure is increasing as prices rebound.

Recognizing the Hammer can help traders anticipate shifts in market sentiment and make informed decisions. Whether you're trading stocks, forex, or cryptocurrencies, understanding and applying this pattern can enhance your trading strategy and improve your entry and exit points, ultimately leading to more successful trades and better risk management.

When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss.

Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.