Inverted hammer

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Inverted hammer is a bottom reversal signal characterized by a single candlestick which has a really long upper shadow and a small real body at the lower end of the trading range. While the color of the real body is not significant, a white real body is perceived to have slightly more bullish implications than a black real body. An inverted hammer's upper shadow should be at least twice the actual body size. A small real body and long upper shadow suggest that the bulls started to step in and they were also able to take the price higher during the session. Following an inverted hammer, a bullish confirmation in the form of an open or a close above the inverted hammer's real body is suggested strongly (V. Quseynov 2013, p. 68).

The Inverted hammer has a long wick on the top and the candle occupies a small part of the bottom of the entire candlestick. The body may be white or black and that is because the high is way above the rest of the candlestick, you can see that most of the trading activity occurs in a small area near the low. The low serves as a support level for upcoming days (R. Rhoads 2011, p.134).

Criteria of a shape

Inverted hammer has specific criteria's of shape (V. Quseynov 2013, p. 69):

  • There is a downtrend in progress.
  • We can see a candlestick with a small real body at the lower end of the trading range, also the real body of this candlestick must be white or black.
  • The upper shadow of the candlestick is at least twice as big as the real body.
  • The lower shadow is either missing or it is very small.

Psychological aspects

In a market where the mood is considered bearish, a bullish inverted hammer occurs. The market opens near its lows. Immediately, the bulls enter the market and push the prices higher. However, the bulls prove to be unable to sustain the rally until the end of the session. The price then goes back and the bears manage to have a close near the lows of the day. This fact or a sudden bull attack and the rally (even if temporary) caused by it shows that the bears are not as strong as they seem to be (M. Thomsett 2010, p. 53).

Like many bullish patterns, the bullish Inverted hammer is predicted by some sort of downtrend. The setup day is a down day-a continuation of the present downtrend. The inverted hammer is the signal day. It's just a different version of the hammer pattern (R. Rhoads 2011, p.134).

Key point

The Inverted hammer is a valuable double-stick move, but it occurs very rarely. As a consequence, it is easy to don't notice, the main rule about the hammer candlestick is that it appears as a sign that price action was strong on one side of the trade; when it appears as the signal day in double-stick pattern, it is even stronger. As with all formations, the movement in price is more important than what any single day reveals (M. Thomsett 2010, p. 54).

Examples of Inverted hammer

  • The Inverted Hammer candlestick is often seen at the bottom of a downtrend and signals that the sellers are exhausted and buyers are starting to take control of the price. An example of this would be seen in the chart of Apple Inc (AAPL) from October 2018. After a long downtrend, an Inverted Hammer candlestick formed on October 24th, signaling the potential for a reversal in the trend. Over the following weeks, the stock rallied sharply, gaining more than 20% in the following weeks.
  • Another example of an Inverted Hammer candlestick is seen in the chart of Dow Jones Industrial Average (DJIA) from January 2020. After a long period of decline, the index formed an Inverted Hammer candlestick on January 3rd, signaling that the sellers were exhausted and buyers were starting to take control of the price. Over the following weeks, the index rallied strongly, gaining more than 10%.
  • Yet another example of an Inverted Hammer candlestick is seen in the chart of Amazon (AMZN) from December 2019. After a long period of decline, the stock formed an inverted hammer candlestick on December 11th, signaling that the sellers were exhausted and buyers were starting to take control of the price. Over the following weeks, the stock rallied strongly, gaining more than 15%.

Advantages of Inverted hammer

  • Inverted hammer is a potentially powerful bottom reversal signal. This means that it can alert the traders of a potential trend reversal in the security's price.
  • The Inverted Hammer candlestick can be used to identify oversold conditions in a market. This can be especially useful for short-term traders who are looking to buy in a market that appears to be oversold.
  • Inverted Hammer candlesticks can also be used to confirm a trend reversal. If the security's price opens or closes above the real body of the Inverted Hammer, this can be seen as an indication that the security's price is likely to continue to rise.
  • The Inverted Hammer candlestick can be used to identify buying opportunities in a market that appears to be oversold. This can be especially useful for longer-term traders looking to buy in a market that appears to be bottoming out.

Other approaches related to Inverted hammer

  • An inverted hammer can also be used as a topping pattern by closely monitoring the candlestick’s high, low and close. If the close is below the open, it suggests that the bears were able to take control of the session and it acts as a bearish reversal signal.
  • Traders can also look for confirmation by closely monitoring the candlestick’s volume. If the volume is higher than normal, it suggests that the bulls were able to take control of the session and it acts as a bullish reversal signal.
  • Traders should also watch for the formation of higher highs and higher lows. If the price is able to form higher highs and higher lows, it suggests that the bulls were able to take control of the session and it acts as a bullish reversal signal.

In summary, an inverted hammer is a reversal signal that occurs when the price action forms a long upper shadow and a small real body at the lower end of the trading range. It is important to closely monitor the candlestick’s high, low, close, and volume for confirmation. Additionally, traders should watch for the formation of higher highs and higher lows in order to confirm the reversal signal.


Inverted hammer — recommended articles
Gravestone doji — Three white soldiers — Dragonfly Doji — Bearish divergence — Bullish divergence — Price pattern — Uptrend — Bull flag — Symmetrical triangle

References

Author: Szymon Olejniczak

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