How to identify the candlestick pattern "Inverted Hammer"?

Candlestick charts are a treasure trove of information for traders. Despite the many variations of candlestick patterns, it is important to understand their essence. Let's consider how to correctly interpret and apply the “inverted hammer” pattern when analyzing momentum or market trends.

The inverted hammer is usually considered a potential reversal signal in the trend. As a well-known bullish reversal pattern, it most often appears at the end of a downtrend. The inverted hammer has a distinctive shape that is easily recognizable on a chart.

This pattern is a variation of the regular hammer. Although the hammer is usually easy to identify, there are exceptions. Sometimes the inverted hammer is confused with the shooting star. They look almost identical - a small body and a long upper shadow, but the shooting star indicates a potential bearish reversal. Therefore, it is important for traders to understand the characteristics of each pattern.

What does the “Inverted Hammer” candle look like?

The Inverted Hammer consists of three parts: the body and two shadows. The real body is short, resembling a horizontal rectangle. The upper shadow is long, at least twice the length of the body. The lower shadow is very short or absent. The name of the pattern is related to its shape, which resembles an inverted hammer.

How is an inverted hammer formed?

This pattern forms when the opening, low, and closing prices are approximately the same. It occurs during or after a downtrend and signals a probable reversal. The appearance of the inverted hammer indicates that bulls are ready to change the trend after bears have pushed prices down. The long upper shadow shows attempts by bulls to push the price as high as possible. The short lower shadow reflects bears' resistance to the price increase.

The inverted hammer is a one-day bullish reversal pattern. Its body can be either bearish ( opening above the close ) or bullish ( closing above the opening ). In either case, it is seen as a sign of the end of a downtrend and an expected market reversal.

Trading with the Inverted Hammer

It is important to understand that no pattern can be fully informative when analyzed in isolation. Simply detecting an inverted hammer is not enough for successful trading in any market, whether it be forex, stocks, or cryptocurrencies.

When evaluating a position, other key factors such as price action and pattern location should also be considered. After correctly identifying the inverted hammer, the trader needs to look for additional signals that confirm a likely reversal. However, this pattern alone is just a warning, not a direct buy signal.

Since an inverted hammer is not considered a decisive signal, it is better to use it in conjunction with some classic technical analysis patterns.

Double Bottom

Double bottom is one of the most reliable reversal patterns. It resembles the letter “W”, consisting of two consecutive minima that are approximately at the same level with a moderate rise between them.

The inverted hammer at the second minimum confirms a double bottom, and both indicators signal a likely market reversal upwards. The trader should wait for a close above the maximum of the inverted hammer to open a long position.

V-shaped bottom

This is another pattern of technical analysis, named after the shape of a letter. It looks like the letter V and occurs when there is a shift in momentum from aggressive selling to aggressive buying.

The inverted hammer is usually formed before the trader enters a position. When the market closes above the maximum of the inverted hammer, it is a signal to open a long position. It is important to note that both patterns are better traded with a support level, as they tend to bounce off the trend.

There are other ways to use the inverted hammer in trading. For example, traders can use it to enter on pullbacks in an uptrend.

Trading Rules

This pattern can be incorporated into a profitable day trading strategy, taking into account some common considerations and scenarios. Since this is a bullish candlestick pattern, only buying rules apply to it.

Turning points. It is extremely important to identify potential price turning points on the chart, such as support and resistance levels, ascending trend lines, etc.

Entry time for a trade. It is permissible to enter after the confirmation candle has formed. Such a strategy reduces entry risks but increases the purchase price and decreases potential profit.

Stop-loss. Traders set stop-losses according to their trading approach. They are usually placed 2-3 pips below the minimum of the inverted hammer. It is extremely important to strictly adhere to the stop-loss, as trading candle patterns is never error-free.

Trading features. Some important points to consider:

• The longer the upper shadow, the higher the probability of a reversal.

• The color of the candle does not matter; however, a white ( green ) candle is considered a more bullish sign than a black ( red ).

• Pay attention to the body of the confirming candle. The larger it is, the stronger the signal for an upward reversal.

Advantages and Disadvantages of the “Inverted Hammer” Candle

There is no perfect pattern that works all the time and everywhere. The inverted hammer is no exception. It has several clear advantages:

• Ease of identification. It has a recognizable shape on the chart and is difficult to confuse with other patterns.

• Relatively high probability of a successful transaction.

However, these advantages are accompanied by disadvantages. The main disadvantage inherent in all strategies is that the pattern may not work even with correct identification.

An inverted hammer can signal a short-term spike rather than a long-term trend. Additionally, sometimes further confirmation is needed, which leads to a loss of some potential profit.

Inexperienced traders may confuse this pattern with its bearish counterpart - the shooting star. They may miss the opportunity, even though the signal is clear.

Differences Between the Inverted Hammer and the Shooting Star

The shape of these two candles is identical. A short real body is combined with a long upper shadow and a tiny lower shadow or its absence (. Both patterns can be viewed as a potential trend reversal signal. However, the key difference between them lies in their position on the chart.

The inverted hammer always appears at the end of a downtrend. In contrast, the shooting star occurs at the peak of a trend and signals a potential price movement downward. Thus, these two patterns are similar in shape but provide traders with different signals.

Conclusion

Candlestick charts are an essential part of technical analysis. The chances of success largely depend on how well a trader is familiar with candlestick patterns and how to apply them, regardless of the traded asset. A candle by itself cannot be a trading signal. Instead, it is best to get an accurate and comprehensive picture when interpreting a candlestick pattern.

The development of the market is based on a combination of factors, not just one element, and this fact cannot be ignored. “Trend reversal” should not be taken literally. The appearance of an inverted hammer on the chart does not mean that the price will necessarily change direction. It indicates a shift in market sentiment, so traders should be prepared to look for other signs of upcoming movements. The “Inverted Hammer” candle can certainly be a useful tool for those who know how to use it in conjunction with other signals.