What is a Hammer candlestick pattern and how to trade it?

Earlier we had a fundamental post on candlesticks where we answered some basic questions like what are candlesticks, what they show, and how to read them? Today we will learn about a candlestick pattern called, the Hammer Candlestick pattern. In this post, you will learn what these hammer candlestick patterns are, what they look like in a chart, the psychology behind this pattern, and how to trade this pattern? So, Let's get started.

What is a Hammer Candlestick Pattern?

A Hammer is a bullish reversal candle stick pattern. As the name suggests, a hammer candlestick looks like a hammer on a chart. It is characterized by - 

1) A small body.

2) A large lower wick (more than twice the body).

3) A small or non-existent upper wick.

4) Of any colour- red or green

See this in the image below.

Hammer Candlestick pattern

Now that you have a preliminary idea of the Hammer candlestick, let's see it in a chart.

The daily chart of NIFTY shows several Hammer patterns marked with black arrows and labeled

Now let's understand the psychology behind this candlestick pattern.

The psychology behind the Hammer candlestick pattern-

In the previous post on candlesticks, we learned that candlesticks don't only show the prices but also the traders' psychology behind those prices and price movements. So, let's understand the psychology at work in the case of the Hammer pattern.

A hammer pattern illustrates that after opening, the sellers were in control and took the price considerably down as shown by the long lower wick of the hammer. But later on, the bulls or buyers became more aggressive and took the prices up, ultimately closing near the open (as shown by the small body). So, a hammer pattern has bullish sentiments attached to it.

Though a hammer candlestick pattern is bullish but does that mean we should buy every time we find a hammer in a chart? Are all hammers worth trading? Which hammer can be traded and which one should be ignored? How to trade a hammer if it is worth trading? Let's find the answers to these questions in the paragraphs that follow.

How to trade a Hammer Candlestick Pattern?

All hammers are not important. Since a hammer pattern is a bullish reversal pattern, so, a valid hammer should be preceded by a downside movement. A hammer-like pattern occurring after an upside is called a hanging man pattern and is a bearish sign.

A tradeable hammer should appear after the price has fallen.

Secondly, a hammer appearing near an important support level is the one that should be traded.

 

Now, once you have spotted a hammer pattern following a price downfall and near a support area, your next step is to mark the high and low of the hammer, that is, the top of the upper and lower wick.

You would buy once the price closes above the high of the hammer with stop loss placed just below the low of the hammer.

Let's see this in a chart.

Let's take a look at another chart to see how a Hammer candlestick can be traded.

Remember here that a hammer candlestick should not be traded in isolation. Price action, momentum indicators, and volume must also be seen before going for a trade and you should trade only when other indicators are in agreement with the price pattern.

Hope you got some insight into the Hammer candlestick pattern through this post. In the next post, we will discuss another bullish reversal pattern- the Engulfing pattern, so, stay tuned.