Japanese candlestick patterns are one of the most popular technical analysis tools. Among them, the Inverted Hammer model stands out as a potential indicator of trend reversal. Let Forex Trading explore with you the concept and uses of the inverted hammer candle through the following article!
What is an inverted hammer candle?
Along with the engulfing candle, the inverted hammer candle or Inverted Hammer is a popular candlestick pattern. It signals a possible reversal from a downtrend to an uptrend. Its characteristic is a short candle body with a long shadow pointing upward, like an upside-down hammer. Whether the candle is green or red, it is important to get confirmation from the next candles. The purpose is to clearly identify the reversal.
What is an Inverted Hammer?
An inverted Hammer is one of the candlestick patterns that represent a reversal that often appears at the end of a downtrend. It shows the possibility that the trend is about to clearly change from down to up. The characteristic of the Inverted Hammer pattern is a candle with a short body and a long shadow pointing upward. It is shaped like an upside-down hammer.
This is one of the popular Japanese candlestick patterns on stock charts. It brings high trading efficiency so it is trusted by many investors. However, the Inverted Hammer pattern is often confused with the Shooting star candlestick pattern. The reason is because they have similar shapes. The difference is that the Inverted Hammer appears at the end of a downtrend. While shooting stars appear at the top of an uptrend. Besides, the Inverted Hammer is also an inverted version of the Hanging Man candlestick pattern.
See more: Read candlestick charts: Basic & advanced material
Characteristics of the inverted hammer candle
Although the Inverted Hammer has a quite simple shape. However many investors often confuse it with other candlestick patterns with similar designs. Investors should note some outstanding features of the Inverted Hammer model as follows:
- The inverted hammer candle has a small and short body.
- The lower candlestick’s wick is often very short or almost absent. Meanwhile, the upper candle’s wick is very long, usually at least twice as long as the candle’s body.
- The pattern can be a green candle (indicating rising prices) or a red candle (indicating falling prices). Because its color is not the deciding factor. However, a green candle usually shows a stronger reversal signal. At the same time, it brings greater safety to investors.
- An inverted hammer candle often appears at the bottom of a downtrend. It shows that the market may be about to reverse to the upside. However, to increase reliability, confirmation from the next candles is needed. If the candle after the Inverted Hammer is a strong bullish candle or there is an upward GAP gap between the two candles. This will further reinforce the effectiveness of the inverted hammer candle model.
Example of the Inverted Hammer model
As mentioned, the color of the green (bullish) or red (bearish) candlestick is usually not the most important factor in the Inverted Hammer pattern. However, there are actually some differences between a bullish Inverted Hammer and a bearish Inverted Hammer.
Green inverted Hammer candlestick
Before the Inverted Hammer pattern forms, the market is usually in a downtrend. The candle right before the Inverted Hammer is usually a green candle. A special feature of the Inverted Hammer is that the closing price is almost the same as the opening price.
What should be noted is that even though the inverted hammer candle pattern has appeared. But the trend reversal has not yet been confirmed. For the pattern to be validated, the next candle needs to be a green candle with strong upward momentum. The price trend will actually reverse and may continue to increase in the next trading week.
Red inverted hammer candlestick
When the red Inverted Hammer appears, it is usually accompanied by a small gap down. It shows that buying pressure is starting to increase. However, the buying pressure here will not be as strong as when the green Inverted Hammer appeared.
However, the next confirmation candle, with a blue body and is quite a large size. This is a clear sign that the bullish trend will continue in the near term.
Inverted Hammer at the top
When the Inverted Hammer appears at the top, it is called a shooting star candlestick pattern. This is the important difference between the Inverted Hammer and the shooting star candle.
Special meaning in technical analysis of the inverted hammer candle model
Like the pin bar candle, the Inverted Hammer pattern is an important technical analysis tool. It is often used to look for reversal signals from a downtrend to an uptrend. It appears when the market tests higher prices.
Special meaning in technical analysis of the inverted hammer candle model
Like other bullish reversal candlestick patterns, the Inverted Hammer carries with it an important meaning. And you will be able to apply the Inverted Hammer model more effectively in your investment strategy when you understand them clearly:
- The Inverted Hammer pattern shows that the market is starting to test higher price levels. Especially with the expectation that the uptrend will continue to push prices up further.
- If in the next trading session, the price is within the body range of the Inverted Hammer. This shows that investors who shorted at the close and open prices are experiencing losses.
- The long upper shadow in the Inverted Hammer pattern reflects the strength of the buying side. It shows that they are trying to push prices up after being controlled by sellers.
Advantages and limitations of the Inverted Hammer model
Inverted hammer candle has both advantages and disadvantages when applied to trading strategies:
Advantage
- Ideal entry point: If the Inverted Hammer quickly creates a new uptrend. Investors can join the market from the early stages of this trend. They take advantage of every opportunity to increase prices to gain profits.
- Easy to recognize: The Inverted Hammer has a characteristic shape, easily recognized on the chart.
Limit
- Too dependent on a single candle: An inverted Hammer is a single candle that reflects price action. If investors only rely on this candlestick to determine the market’s reversal. It does not examine other supporting evidence or indicators. They may encounter unexpected results.
- Short-term retracement: the inverted hammer candlestick can indicate a temporary price increase that is not necessarily a long-term reversal. This can happen if buying pressure cannot be maintained. Especially in the context that the downtrend is still dominant.
Psychological developments of the inverted Hammer candlestick pattern
In a downtrend, prices continuously fall deeply. When the buying force accumulates strongly enough, the price is pushed up in a short period of time. Buyers put all their effort into bringing prices to the highest possible level. This creates a long upper shadow.
However, this price increase usually does not last long. The market tends to return near the opening price. The short lower shadow of the candle shows that buyers have tried to keep the price from falling too deeply. At this point, the Inverted Hammer pattern suggests that the market is starting to test higher price levels.
When the market tried, but failed the first time. We need to wait for at least one other confirmation signal before taking action.
Instructions for effective trading with the inverted Hammer candlestick pattern
This is a pattern that can predict a reversal from a downtrend to an uptrend. It is important to combine many different technical indicators to get an overall view.
Steps to have truly effective trading with the inverted hammer candle model
An important piece of advice is to combine multiple technical analysis indicators. The purpose is to increase the accuracy of trading decisions. Investors can gain a more comprehensive view of the market and reduce risks.
Combined with support levels
The Inverted Hammer model tends to perform better when appearing at a strong support zone. Because support lines often signal the possibility of price reversing from decreasing to increasing. Therefore, trading in these areas often comes with lower risks. Detail:
- When the price is in a downtrend and the Inverted Hammer pattern appears at the support zone. You can consider entering a buy order at the closing price of Inverted Hammer. Especially if it is a green candle.
- Place a stop-loss order just below the support line.
- Place a take-profit order at the nearest resistance level. As long as the standard reward/risk ratio (R: R) is achieved, like 1:1 or 1:2.
Use with Fibonacci Retracement
This is a method applied by many experienced investors. Make sure that the Inverted Hammer pattern appears at the end of the downtrend.
- When the market drops and hits the 38.2% Fibonacci retracement level. The appearance of the Inverted Hammer pattern is a sign that this may be the right time to place a pending buy order. Investors can place a pending buy order at a level about 1-2 pips higher than the top of the pattern. If the price increases, the order will be automatically activated. However, if the price continues to decrease, the order will be automatically canceled, helping to limit the risk of loss.
- The stop loss is placed about 2-3 pips below the bottom of the inverted hammer candlestick.
- Take-profit levels can be set at strong resistance areas. Or it could be at a profit level that is 2 – 3 times the stop loss.
A few notes when trading with the inverted hammer candlestick pattern
To trade effectively with this model, investors need to pay attention to the following points:
- The Inverted hammer candle signaling an uptrend reversal is often more reliable than the Inverted Hammer reversing the downtrend. This candlestick pattern represents the struggle between buying and selling forces. When the Inverted Hammer appears and is a bullish candle. It can confirm the victory of the buyer. However, the Inverted Hammer is a bearish candlestick but can still lead to a reversal to an uptrend.
- The Inverted Hammer model has a higher chance of winning when it appears at the support zone. Inverted Hammer patterns will be more reliable if they form within a support area. Such as trend lines, static support zones, or lower Bollinger bands. In this case, price targets tend to move longer.
See more: Together XM Forex: Master the game, increase income
Conclude
Although the inverted hammer candlestick is a useful tool to identify possible trend reversals. But it is not always synonymous with a buy or sell signal. Furthermore, the Inverted Hammer model will bring greater value when combined with other technical analysis tools and indicators. Investors should apply sound risk management and carefully evaluate the probability of success of each trade. That is what Forex Trading wants to provide about the inverted hammer candle. Follow Forex Trading now to learn more about Inverted Hammer!
Question related to inverted hammer candle
What is the difference between an Inverted Hammer and a shooting star candle?
Inverted Hammer appears at the end of a downtrend, signaling a possible reversal to the upside. While shooting star candles appear at the end of an uptrend, signaling a possible reversal to the downside.
Step by step to effectively trade with inverted Hammer candlesticks?
When you see the Inverted Hammer appear at the end of a downtrend, investors can consider it a buy signal. However, for confirmation, they should wait for the next signal. For example, a strong bullish candle or high trading volume should be combined with other indicators such as RSI or MACD to increase the reliability of the signal.
Does the inverted hammer candle always signal a reversal?
An inverted Hammer does not always signal a reversal. To increase accuracy, investors should use other confirmation factors. Combining the inverted hammer candle with technical analysis and other trading strategies will help reduce risk.
