Interpretation of the inverted hammer candlestick pattern

Japanese candlestick charts are an essential tool for any trader in the financial market. Despite the wide variety of existing candlestick patterns, it is crucial to understand how they work. If you are analyzing the momentum or trend of the market using an inverted hammer candle, we will explain how to interpret it correctly and apply it strategically.

The inverted hammer is a type of candlestick pattern that is considered a possible trend reversal signal. Being a recognized bullish reversal pattern, it typically forms at the end of a downtrend. Its characteristic shape and distinctive position on the chart make it easily identifiable among other patterns.

This pattern is a variant of the traditional hammer. Generally, it is easy to recognize a hammer pattern, although there are some exceptions. Sometimes, the inverted hammer can be confused with the shooting star pattern. Both have a small body and a long upper shadow, but the inverted hammer indicates a possible turning point in a downtrend. For this reason, it is crucial for traders to understand the particularities of each pattern.

Characteristics of an Inverted Hammer Candle

The inverted hammer consists of three elements: a body and two shadows (wicks). The real body is short and has a rectangular shape. The upper wick is extensive and must be at least twice as long as the real body. In contrast, the lower wick is very small or nonexistent. This pattern gets its name due to its resemblance to a hammer flipped upward.

Inverted Hammer Formation

This pattern is generated when the opening, low, and closing prices are approximately equal. The inverted hammer appears during or after a bearish trend, signaling a probable reversal. It forms when bullish traders are willing to change the direction of the market after a period of bearish dominance. The upper wick reflects the attempts of the bulls to raise the price, while the lower wick, if present, represents the resistance of the bears.

The inverted hammer is a one-day bullish reversal pattern. Its real body can be bearish (open higher than close) or bullish (close higher than open). In any case, it is interpreted as a signal of possible trend change when it appears at the bottom of a downward movement.

Trading Strategies with the Inverted Hammer

It is important to remember that no pattern alone provides complete information for trading. The mere identification of an inverted hammer candlestick is not enough to make successful trading decisions in any market, whether forex, stocks, or cryptocurrencies.

There are other key factors to consider, such as price action and the position of the candle in the overall market context. Once the pattern is correctly identified, it is necessary to look for additional signals that confirm the possible reversal. However, this should be considered a warning, not a definitive signal to open a position.

Since the inverted hammer is not considered a conclusive signal by itself, it works best in combination with other classic patterns of technical analysis.

Double bottom

The double bottom is one of the strongest reversal patterns. Its shape resembles the letter "W", as it consists of two almost identical consecutive lows, with a moderate peak between them.

The appearance of an inverted hammer at the second low of this pattern reinforces the double bottom signal, indicating a likely market rise. In this case, it is recommended to wait for the price to close above the maximum of the inverted hammer before opening a long position.

Ground in V

This is another technical analysis pattern that gets its name from its similarity to a letter. Its shape resembles the letter V and occurs when the price momentum abruptly shifts from strong selling pressure to strong buying pressure.

The inverted hammer is typically formed just before the entry point in this type of pattern. When the market closes above the maximum of the inverted hammer, it may be the right time to open a long position. It is important to trade these patterns in conjunction with support levels, as they tend to bounce in trends.

Of course, there are other ways to use the inverted hammer in trading. For example, traders can take advantage of pullbacks in an uptrend, using the inverted hammer as an indicator of a possible entry point during a correction.

Trading Rules

This pattern can be incorporated into a profitable intraday trading strategy if some general considerations are taken into account. Being a bullish pattern, rules for buying trades only apply.

Reversal Points: It is essential to identify potential price reversal points on the chart. These can be support and resistance levels, upward trend lines, among others.

Entry moment: It is recommended to enter the trade after the formation of a confirmation candle. This strategy involves a lower risk when starting a position, although the purchase price will be higher and potential profits will be lower.

Stop loss: Traders set their stop loss levels according to their trading approach. As a general rule, they are usually placed 2 or 3 units below the minimum of the inverted hammer candle. It is crucial to strictly adhere to the stop loss, as trading with candle patterns is never without risks.

Important considerations:

• The longer the upper wick, the greater the likelihood of a reversal.

• The color of the candle is not decisive, although a white ( or green ) candle is considered slightly more bullish than a black ( or red ) candle.

• Pay attention to the body of the confirmation candle. The larger it is, the stronger the bullish reversal signal.

Advantages and disadvantages of the inverted hammer

Like any pattern, the inverted hammer has its pros and cons. Among the most obvious advantages are:

• Ease of identification: Its characteristic shape makes it recognizable on the chart and difficult to confuse with other patterns.

• Relatively high reward potential.

However, it also has some disadvantages:

• It may fail for no apparent reason, even if it is correctly identified.

• It may indicate a short-term spike, but not necessarily a long-term trend.

• Sometimes it requires additional confirmation, which may result in a loss of potential benefits.

• Novice traders may confuse it with its bearish variant, the shooting star.

Differences between the Inverted Hammer and the Shooting Star

Although the shape of these two patterns is identical (short body, long upper wick and small or nonexistent lower wick), their interpretation depends on their position on the chart.

The inverted hammer appears at the end of a downtrend, while the shooting star forms at the top of an uptrend. In summary, these patterns have similar shapes but provide opposite signals to traders.

Conclusion

Japanese candlestick charts are an integral part of technical analysis. Success in trading largely depends on the trader's familiarity with candle patterns and their ability to use them correctly, regardless of the asset in question. An isolated candle cannot be considered a definitive trading signal. It is preferable to obtain a holistic and accurate view when interpreting candle patterns.

The confluence of factors is the basis for anticipating market movements, and this fact should not be ignored. The term "trend reversal" should not be taken literally. The appearance of an inverted hammer on the chart does not guarantee an immediate change in direction, but rather indicates a possible change in market sentiment. Traders should be prepared to look for other confirming signals of future movements. The inverted hammer can be a useful tool when used in conjunction with other indicators and technical signals.

Notice: This article contains opinions and should not be considered financial advice. It may include sponsored content. Please review the terms and conditions before making investment decisions.