- June 17, 2020
- Posted by: CoachShane
- Category: Trading Article
The presence of a Hammer candlestick pattern does not mean you should jump into a trade.
Some traders will use the term “pin bar” but what we are talking about is still the Hammer candlestick.
What matters, is context and we are going to discuss that after we learn what a Hammer candlestick is.
What is the hammer candlestick pattern
The Hammer is a one candlestick bullish reversal pattern that we would look for when the price is declining.
Features of a hammer candlestick are:
- A small real body that closes in the top 1/3 of the candlestick range
- The shadow is at least 2X as large as the body
- There is almost no upper shadow
- The real body can close red but that hammer is not as strong as one that closes with a green body
Not too complicated but here is what the hammer candlestick means:
- Price opened and sellers stepped in and drove the market down
- Buyers picked up the pace and drove price higher past the opening price
- Buyers were strong enough to hold the candlestick near or at the highs of the day
That is a general explanation but there are a few ways the hammer can form:
As you can see, it is not always as simple as sellers being totally overwhelmed by the buyers with lower prices being fiercely rejected. Comparing the two formations above, you can see the one on the left was move convincing of strong bulls.
The textbooks won’t show you this nor will online “gurus”, but be aware of what is hidden inside of the candlestick that forms.
Facts About The Hammer Candlestick You Must Know
There is nothing magical about the hammer but there are some vital things you need to know before you trade them:
- Hammers are lower time frame retracements in the price
- They can appear on your time frame in up and down markets – they do not determine the trend direction
- Where the hammer forms matter most when using them
Let’s break each one of these down:
1. Lower time frame retracement
In the last graphic, I showed you a different way the hammer can form.
Remember, we look for the hammer candlestick to form during a down move in the price direction. This means, that in the downtrend, the price will move up to form the hammer. The higher the time frame, the move obvious this should be.
But on the lower time frame, we can see it is just a retracement in the price:
What is interesting is that the hammer candlestick came in around a previous resistance turned potential support zone.
Going long, buying would have resulted in a losing trade.
2. Can’t be used to tell you the trend direction
From engulfing candlesticks to our Hammer, these are individual candlesticks.
If you look at the posted charts, each leg in a swing has many candles – even more on lower time frame charts.
Seeing a reversal candlestick and thinking that we are going to see a trend change is wishful thinking.
Use other means, such as trading indicators or structure, to determine the direction of the market.
3. The state of the market determines our usage of the Hammer
How you use the Hammer will depend on the market condition we are facing.
Is the market trending up or down?
Are we in a consolidation phase?
We should expect to see Hammers form in uptrends but in downtrends, it does not mean we are changing direction.
In a trading range? We can use the Hammer depending on where it forms.
Hammer Candlestick Trading Strategy
If you wait to find Hammers for trading, you will be waiting a long time. They do not always occur at potential turning points so keep in mind what we are really looking for.
We are looking at signs of a reversal. It can be a Hammer or any other pattern that shows the balance of power leaning towards the buyers.
- Look for a trending market. You can use a trading indicator like the 50 period moving average or use higher highs and lows to show an uptrend.
- Price retraces back into a prior resistance zone that has been broken
- Look for a reversal candlestick such as the Hammer
This is a 15-minute Forex chart
We see the market is in an uptrend as shown by price action and the moving average.
The red arrow points to the hammer candlestick that has formed in an area of interest.
The red line is a former resistance level now acting as support. As you can see, support held.
How to trade this setup
The trade setup has occurred in an area of interest. The Hammer reversal candle shows us buyers taking over but to be sure, we place our buy stop order just above the high of the Hammer.
We need to set our stop loss and we do this via the average true range indicator. Think of using 1.5-2X the 20-period ATR of price.
You can use previous swing highs or multiples of the ATR risk for your take profit areas.
The key is that we see the reversal set up while the price is near or at ann area of support.
Hammer Bonus Strategy
This is one of my favorite techniques using the Hammer candlestick and it goes against the common rules.
What rule does it break? The market is in a trend.
For this strategy, I want to see price in a range and I don’t need a perfect-looking Hammer candle.
Once you define the trading range, look to the bottom of the range for support to be broken and then regained.
- Stop loss is under the low of the hammer – if we are wrong, we will be wrong if the low breaks
- Profits can be taken at the top of the range
One more way to use the range strategy……
If you are in an uptrend and price is retracing, dial into a lower time frame for your entry.
Once the pullback begins to end, we can often see a small range forming. If we get a hammer, we are using the trigger (break of hammer high) as entry into the higher time frame pullback.
This allows us to get into the trade long before the higher time frame shows a resolution of the pullback.
The Hammer candlestick is a one candle pattern that can be used as triggers into a trade.
Where we find the Hammer matters so we look to support and former resistance levels being tested.
Don’t use it as a trend determination tool.
We can match ranges and pullbacks with the Hammer for early entry into trades.
Let me know if you use any type of candlestick patterns and if so, which ones are your favorite.