Technical analysis is an essential instrument for forecasting price moves in the global economic markets. A popular method is to analyze candlestick charts and recognize certain patterns.
One of the most frequently used patterns by traders is the «Hammer». It assists in determining the reversal points of a trend, both upward and downward. This pattern is applicable to the cryptocurrency, stock and bond markets.
In this article, we will look in detail at what the «Hammer» is, what its varieties are and how this tool is used by traders in practice to open profitable deals.
How do candlestick patterns work?
A candlestick chart displays the price dynamics of assets for certain time intervals. Thus, each candlestick on the chart shows how the value of cryptocurrency has changed over a specific time period. For example, on a daily chart, one candle corresponds to one day of trading, while on an hourly chart it corresponds to one hour.
The structure of a candle includes the opening price, the closing price, as well as the maximum and minimum prices for a given period. By analyzing their shape and size, location relative to each other, traders find repetitive combinations of candlesticks. Such combinations are called patterns.
Recognizing patterns requires experience and knowledge of basic patterns. For beginner traders, we recommend studying our guide «Popular candlestick patterns: how to read them correctly». By combining technical analysis with other methods, you can increase the efficiency of trading on the crypto market.
Features of the pattern «Hammer»
One of the popular classic candlestick pattern on the chart is the «Hammer». It helps to determine the points of potential upward or downward trend reversal.
«Hammer» is a candle with a small corpus and an extended bottom shade, exceeding the size of the body at least 2 times. Visually, it can be divided into 2 elements: the corpus itself, displaying the open and close values of the time period, and the shadow, showing the minimum and maximum value of the asset for a given trading interval.
This pattern indicates a sharp drop in price after the opening, caused by sales. But then more active buyers pushed the quotes back up, and the close value turned out to be above the open. This pattern often indicates an upward trend reversal after a drop in the value of an asset.
Bullish pattern «Hammer»
The classic bullish pattern «Hammer» is generated when the close price is above the open price of the asset. This means that in the course of trading, buyers were able to regain control of the market and push the quotes back up before the close of the period.
Another variation of the «Hammer» is the inverted or inverted pattern. In it, the opening price is located above the close price, and the longer top shade demonstrates unsuccessful attempts of buyers to raise the price of the asset. This pattern also indicates the exhaustion of the downtrend and the upcoming upward reversal. However, the signal here is more blurred than in the classic bullish variant of the «Hammer».
Bearish pattern «Hammer»
In addition to the bullish one, there is also a bearish version of the «Hammer», which also has two main varieties.
The first one, the Hanged man, appears when the period’s open value is higher than the close value, forming a red/black candle. In this case, the longer bottom shade shows the dominance of «bears» (sellers) and a possible change from an upward trend to a downward trend.
The second type is the Shooting star. This pattern resembles the inverted «Hammer», but appears after the price growth. Here the opening of the period is also higher than the closing, and the upper shadow indicates the exhaustion of buying activity and the approaching reversal of the previous upward price movement.
Both of these patterns signal the coming change of trend and the transition of control over the market to the «bears». Recognizing bearish «Hammers» is extremely important for timely opening profitable short positions.
Trend reversal signals: how to detect them with the help of the «Hammer» candle pattern
The «Hammer» pattern can give investors a hint about the moments of possible reversal of both upward and downward trends.
A bullish «Hammer» is usually formed on the background of a falling market, when the price has been falling for some time. The appearance of such a pattern signals the exhaustion of the downward impulse and a possible upward price rebound after reaching a local bottom (minimum).
The bearish variant of the pattern occurs in the conditions of an uptrend, when the value of the asset demonstrates growth. It indicates the potential stopping of the price rise and the beginning of the decline in the value of the asset after reaching the peak.
To effectively apply the «Hammer», it is important to analyze it in the broad context of price movements in the market. Confirmation of the predicted reversal or refutation will become clear from the subsequent price dynamics of the asset. In combination with other methods, this pattern helps to find favorable points for opening positions.
Advantages and disadvantages of the «Hammer» pattern
Any pattern has its advantages and disadvantages. Let’s highlight the main weaknesses and strengths of the «Hammer» pattern.
Benefits:
- «Hammer» allows you to determine possible points of trend reversal both in the cryptocurrency market and in other financial markets.
- This pattern is applicable for different time frames — from minute graphs to daily graphs. This makes it possible to use it for both swing and intraday trading.
Drawbacks:
- The «Hammer» itself doesn’t guarantee a trend reversal after its appearance. It only indicates the possibility of changing the direction of price movement. Therefore, it often happens that a trader opens a deal based on this pattern, but the price continues to rise or fall.
- The «Hammer» pattern by itself isn’t a self-sufficient signal in trading. To increase the reliability of the forecast, it should be combined with other methods of tech analysis — moving averages, oscillators and so on.
Thus, the advantage of the «Hammer» is its versatility, while the disadvantage is its low reliability. To improve the accuracy of the forecast, you need a comprehensive approach with the use of other analysis tools.
Final thoughts
The «Hammer» candlestick model is a valuable instrument for determining the spots of a possible trend reversal. It allows traders to open trades, focusing on a quick change of price direction.
At the same time, this pattern is not a hundred percent signal to buy or sell an asset. There is a probability that the trend will continue instead of the expected turn.
To significantly increase the effectiveness of forecasts, it is recommended to analyze the «Hammer» in conjunction with other tools. Also, to avoid mistakes, it is recommended to use stop-losses. They will automatically close an unprofitable position when a predetermined threshold is reached.
