One thing I hate more than Monday mornings—is having too many choices.
Whenever I look at traders screens it seems that they have hundreds of indicators and endless trend lines drawn on charts.
Talk about sensory overload.
It’s paralzying to even the best traders.
But what if I told you that you can improve your timing and accurately predict market moves—by using one simple candlestick pattern… would you believe me?
Well, I’m going to teach it to you right now, and you can be the judge.
The Hammer candlestick is viewed as a bullish reversal candlestick pattern.
How to recognize a hammer:
- Little to no upper shadow
- Price closes at or near the day high. Top ¼ range acceptable.
- Lower shadow should be at least the same size as the length of the body.
What does this mean?
- When the markets open, the sellers took control and drove prices lower.
- The selling “capitulated” at the bottom, and huge buying pressure stepped in driving price higher.
- The buying pressure is so strong it closed above the days opening price.
Essentially, a Hammer is considered a strong formation because the bulls were in control and were able to reject the bears completely by buying the stock up from the lows and creating the long lower shadow.
The bulls were also able to push prices even further and having the stock close at the high of the day.
The long lower shadow of the Hammer implies that the markets were able to find support zones where the buyers stepped in.
Hammer Candlestick Pattern Example
In this sample diagram above, you can see how the markets sold off and a Hammer pattern emerged followed by a continuation of the uptrend the following bar.
This pattern is an extremely helpful candlestick pattern to show traders where demand levels are located.
This helps to identify that the bears are out of control and the bulls have stepped in at this price level.
Pro Tip: Hammer patterns are best when used with other supporting factors.
The more bullish signals a trader has, the more conviction of higher future prices.
Breaking It Down Further
Basically, all things need to be considered before going long a hammer pattern.
Some important things to remember are:
- A hammer pattern can indicate that there is a retracement imminent
- A hammer alone does not tell you if the direction has changed
- Context of the markets are more important than a single pattern
1: A hammer pattern can indicate that there is a retracement imminent
Many traders make huge mistakes when thinking a trend will reverse because a hammer is formed.
This is just wrong.
A hammer is an extremely bullish indicator and should be viewed as a possible change of direction not an absolute.
2: A hammer alone does not tell you if the direction has changed
Here is why…
A trend is made up of a series of candles. I am talking hundreds or more!
So let me ask you.
What are the odds that a single candlestick pattern determine the trend is changing?
Pretty slim to me.
In order to know the direction of the trend, you should ask yourself…
- “Is the price going to continue lower?”
- “Is the price going to actually reverse direction here?”
- “Is there any other supporting evidence of price change at this level?”
Logically, wouldn’t it need other influencing reasons before a major trend is changed?
I would think so…
3: Context of the markets are more important than a single pattern
Always ask yourself, what does the market think of a reversal here.
Some external factors that impact markets are earnings, news, economic numbers, and fed reports.
If a market is in an uptrend and strong economic numbers have been released, it’s very likely the markets will continue higher (regardless of a bearish hammer pattern that has formed.)
How do I trade the Hammer candlestick pattern?
Hammer Candlestick Trading Strategy
So here’s the deal…
I don’t like to trade these patterns in isolation.
You will end of with thousands of Hammer patterns to trade if you do.
Let’s focus on the 3 main factors to identifying a tradable Hammer pattern.
3 Main Factors:
- What is the major trend
- Is it a strong signal
- Additional supporting indicators
1) The major trend must be in favor of the signal.
This is important, it’s best to remember that “the trend is your friend”.
You don’t want to catch a falling knife while trading this pattern.
It’s ok to buy a dip but need to make sure it’s not used to pick bottoms which could lead to more problems for you.
2) Is it a strong signal
Another important thing to remember is the “strength” the candlestick has.
The stronger the signal, the more likely it is to follow through in the favored direction.
2 things to notice about strength
- The close is farther away from the open showing the bulls have taken full control of the stock.
- The lower shadow is longer indicating a stronger reversal seen intra-day
3) Additional supporting indicators
Like #2, the more supporting indicators you have, the more likely it is to follow through in the favored direction.
There is a reason investigators collect supporting evidence in a crime.
The more pieces of the puzzle that points to a specific person increases the confidence that individual is to be held accountable.
The same goes for trading, the more indicators supporting the candlestick pattern, the better the signal is.
Failing to identify a correct hammer pattern
Failing to identify any one of those 3 factors can lead to a bad trade.
In this example,
- There was no identifiable major trend
- It was a weak signal (red candle and small shadow)
- Only supporting indicator was resistance level
Remember, just because you have 1 out of 3 key factors, doesn’t indicate its a good trade to take.
Putting it all together
Here is an example of some of the most recent Hammers in the SPY.
By combining all 3 key factors it can show some of the most powerful signals!
If you were to follow every one of those simple Hammer candlestick patterns, you would have had 100% winning trades!
Here is a trade the premium members got in the other day and make 35%+ on this options trade!
IWM formed a semi-strong Hammer pattern.
We bought IWM Calls and returned over 35% on this trade by the morning of the next day!
So to conclude, you have learned:
- How to identify a strong Hammer candlestick
- 3 key factors to trading the Hammer candlestick safely
- The Hammer candlestick allows you to find insanely profitable trading opportunities!