In this guide to understanding the Hammer Candlestick Formation
The Hammer candlestick formation is viewed as a bullish reversal candlestick pattern that mainly occurs at the bottom of downtrends. The Hammer helps traders visualize where support and demand are located. After a downtrend, the Hammer can signal to traders that the downtrend could be over and that short positions could potentially be covered.

What is the Hammer Candlestick Pattern?

This pattern forms a hammer-shaped candlestick, in which the lower shadow is at least twice the size of the real body. The body of the candlestick represents the difference between the open and closing prices, while the shadow shows the high and low prices for the period.

When the opening and closing prices are almost the same it shows that the bulls have taken control over the prices.

They have pushed the prices more than the initial opening price.

As Hammer is a bullish reversal candlestick pattern, it should be formed at the end of a downtrend.

The long lower shadow shows that initially, the bears had taken the prices too low, near the support.

But then the bulls came and they eventually took the prices up and closed it more than the opening price.

Formation of Hammer Candlestick Pattern

The Hammer formation is created when the open, high, and close prices are roughly the same. Also, there is a long lower shadow that’s twice the length as the real body. When the high and the close are the same, a bullish Hammer candlestick is formed. In contrast, when the open and high are the same, the red Hammer formation is considered less bullish, but still bullish.

If the Hammer is green, it is considered a stronger formation than a red hammer because the bulls were able to reject the bears completely. Also, the bulls were able to push up the price past the opening price. A red Hammer candlestick pattern is still a bullish sign. The bulls were still able to counteract the bears, but they were just not able to bring the price back up to the opening price.

What does Hammer Candlestick Pattern tells you?

A hammer occurs after a security has been declining, suggesting the market is attempting to determine a bottom. Hammers signal that the bears have lost control over the prices, indicating a potential reversal to an uptrend.

Hammers are most effective when they are preceded by at least three or more declining candles. A declining candle is one which closes lower than the close of the candle before it.

Confirmation occurs when the candle after the Hammer closes above the closing price of the hammer.

This confirmation shows that the bullish reversal has taken place.

Traders should enter long positions only after the confirmation candle.

A stop-loss can be placed at the low of the hammer’s shadow. Hammers aren’t usually used in isolation, even with confirmation. Traders typically utilize price or trend analysis, or technical indicators to further confirm candlestick patterns.

Hammers occur on all time frames, including one-minute charts, daily charts, and weekly charts.

The Difference Between a Hammer Candlestick and a Doji

 

A doji is another type of candlestick with a small real body. A doji signifies indecision because it is has both an upper and lower shadow. Dojis may signal a price reversal or trend continuation, depending on the confirmation that follows This differs from the hammer which occurs after a price decline, signals a potential upside reversal (if followed by confirmation), and only has a long lower shadow.

 

Limitations of Hammer:

The hammer candle does not take the trend into consideration and therefore, when considered in isolation, can provide a false signal.

There is no assurance that the price will continue to move up after the confirmation candle.

A long-shadowed Hammer may push the price high within two trading sessions.

This is not an ideal spot for buying as the stop loss may be at a great distance away from the buying point.

Hammers also don’t provide a price target, so figuring what the reward potential for a hammer trade is can be difficult.

 

Key Takeaways:

  • Hammers have a small real body and a long lower shadow.
  • Hammer candlestick pattern is a bullish reversal and it occurs at the bottom of a downtrend.
  • Hammers signal that the bears have lost control over the prices, indicating a potential reversal to an uptrend.
  • Confirmation occurs when the candle after the Hammer closes above the closing price of the hammer.
  • Hammers don’t provide a price target, so determining profit for this trade may be difficult.

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