Mastering the Inverted Hammer Candlestick Pattern in Technical Analysis Trading

Other tools for the strategy are the support levels and, of course, the Inverted Hammer pattern. Another interesting thing about the Inverted Hammer is that it forms when the market seems oversold, and mean-reversion traders are looking to enter long positions. The Inverted Hammer pattern can also provide traders with insight into market sentiment and the balance of power between buyers and sellers. The pattern is formed when the price opens lower, rallies during the day, but closes near its opening price. The long upper wick indicates that the bulls tried to push the price higher, but the bears fought back and brought the price down.

What does Red Inverted Hammer indicate?

1. Trading success depends on consistent practice, analysis, and response to shifting market conditions.
2. Once identified, they can decide to enter a long buying position and initiate a trade.
3. All these advantages make this pattern versatile, because of which it is used in various assets like cryptocurrencies, forex, and currencies.
4. Long term investors can wait for ‘trend reversal’ candlestick patterns to buy quality stocks close to the bottom.

The hammer-shaped candlestick that appears on the chart has a lower shadow at least twice the size of the real body. The pattern suggests that sellers have attempted to push the price lower, but buyers have eventually regained control and returned the price near its opening level. The long upper shadow indicates that the buyers were able to push the price higher, even though the sellers initially had control. Both the hammer and inverted hammer candlesticks are taken as indications by traders that a bullish reversal might be coming.

Inverted Hammer Candlestick Pattern Explained – (Trading Strategy and Backtest Definition & Meaning)

They see that the trading volume on the Inverted Hammer day is higher than the prior norm, indicating more buying activity. The Inverted Hammer pattern is even more significant because the low of the pattern coincides with a key support level at ₹98. The trader chooses to open a long position while limiting risk by setting a stop-loss order below the pattern’s bottom. Based on local resistance levels or a favourable risk-reward ratio, they also determine a profit objective. The trader’s trade hits the profit objective, resulting in a profitable conclusion, as the price rises in consecutive trading sessions, confirming the bullish reversal.

Interpreting the Inverted Hammer Pattern for Trading Decisions

When the regular inverted hammer appears at the bottom of a trading range after a prolonged downtrend, this could possibly indicate that a bullish reversal is coming. Nevertheless, an inverted hammer can also emerge at the top of an uptrend. The only difference between the hammer candlestick pattern and the inverted hammer is that the wicks are reversed. The inverted hammer candlestick pattern should be traded using a bullish reversal strategy in all markets using a modified entry, according to a 21-year backtest.

How to trade the Inverted Candlestick pattern in the stock market?

He has a vast knowledge in technical analysis, financial market education, product management, risk assessment, derivatives trading & market Research. However, as the market opens the next day, the bears have started to doubt that the market is headed much lower. For the rest of the day, sellers and buyers remain equally strong, and the market closes around the same level it opened. However, the long upper wick and the small lower wick signals that buying pressure was a little stronger than selling pressure. A Japanese rice trader called Munehisa Homma developed the idea of candlestick charts in the 18th century.

Since the inverted hammer candle often signals a reversal in trend, and trends can persist for a long time, traders often identify multiple target levels or simply utilize a trailing stop. As the chart says, the inverted hammer candlestick pattern occurs when the Fibonacci levels are at 38.2% level. As the above GBP/USD 1D chart shows, there is a bullish reversal pattern happening with an inverted hammer candlestick. It can be easily identified by confirming the completion of a candle following the inverted hammer. As mentioned above the inverted hammer pattern shows bullish trends, it’s important to know why is it named so and how traders are supposed to respond to it. The fundamental reason lies in the prices that hesitate to show downtrends during the daytime.

Today, crypto traders use candlestick charts in their technical analysis to forecast what might happen next regarding asset prices. Always use other forms of technical analysis or indicators to complement your decision making process along with proper risk management strategies. Inverted Hammers are nothing more than a hammer-looking candle that has a very long upper wick (approximately two or three times the size of the candle’s body) and little to no lower wick. They serve as a clue of potential future bullish price reversals thanks to the language spoken by candlesticks psychology and price action. The inverted hammer pattern has a small body, a long upper shadow, and little to no bottom shadow, near the top of the pricing range. The body of the inverted hammer pattern is generally red indicating a lower closing price than the opening price.

If you’re working with lower resolution charts, you could benefit from watching the price on higher resolutions as well. In the strategy examples that come soon, we’ll cover an indicator we know has a lot of potential to enhance a strategy. If you have any questions related to the ‘inverted hammer’, you can ask in the comments section below. This is part of the discipline, which is arguably the most important aspect of becoming a successful trader. Observe the chart below and notice how the price of a company called ‘United Spirits’ had been falling continuously for several days.

Do note, a stop loss is very important and absolute must for every trade you take. If the price goes below the ‘inverted hammer’ candle – it means the reason we took the trade has failed. If that is green, the stock should be bought when the price goes above the ‘high’ of the ‘inverted hammer’. After a big fall on the previous day, the stock opens below, rises high and then closes slightly above the opening price.

If you have tall and strong candlesticks with long wicks, then it’s a sign that the market is quite volatile. You could use the average true range indicator to quantify your observation. Every candlestick tells a unique store about the market and how the buyers and sellers interacted. While these stories, like the one we’re going to share with you now, aren’t completely accurate, they’re perfect to get going with your own analysis of the markets. If you want to read more about the shooting star pattern, you can do so in our article on the shooting star candlestick pattern.

Tendencies of this sort exist everywhere, albeit not with every strategy. You could trade strategies that only go long in one half of the month, and short the other, or only trades on even or odd days. For some intraday strategies, a signal that occurs at the beginning of the trading session may be very relevant, while signals during the rest of the day aren’t worthwhile at all. Traders can use the Inverted Hammer pattern for swing trading in an up-trending market. It can also be incorporated into mean reversion strategies by identifying oversold conditions.

The Inverted Hammer Pattern reflects a battle between buyers and sellers, with buyers showing strength in pushing the price higher despite initial selling pressure from sellers. The volume of the assets being traded increases significantly during the formation of this pattern. Sometimes reversal patterns like the inverted hammer might seem to occur at the bottom of the range, while they’re actually at the top of the trend when looking at higher chart resolutions.

It’s used to determine whether the candle’s body is small enough to fit the criteria for an Inverted Hammer. The Inverted Hammer candlestick pattern may appear a little different on your charts. The main difference between both patterns is on where they are located in the trading chart (meaning right after an uptrend or a downtrend). While both look the same, the Inverted Hammer can be found usually after downtrends whereas the Shooting Star can be found usually after uptrends. In the below chart, after a very noticeable downtrend some small buyer pressure begins to build up but it’s not until you see the inverted hammer that you fully notice the accumulated buying pressure. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.

This happens all during a single period, where the price falls after the opening but regroups to close near the opening price. If an inverted hammer forms in the middle of a downtrend or during an uptrend, it may not have the same implications and could lead to false signals. The bodySize variable calculates the absolute size of the candle’s body, which is the difference between the opening and closing prices.

Trading success depends on consistent practice, analysis, and response to shifting market conditions. The body of the Red Inverted Hammer in the pattern is typically coloured red or black, indicating a lower closing price compared to the opening price. The body is observed in various sizes, but it is generally small in relation to the overall candlestick. The Red Inverted Hammer’s upper shadow is very long, signifying the peak price of the asset during that particular period. It demonstrates that despite buyers’ best efforts, sellers ultimately took charge and pushed the price back down.

The Shooting Star pattern has a small size body at the lower end of the price range, with a long upper shadow and little to no lower shadow. The colour of the body is either  red or green, as the colour of the body does not play a major role in the pattern. Most of these limitations are avoidable by proper implementation of the trading strategies, like observing the spike in volume during pattern formation and understanding support and resistance levels. The accuracy of the Inverted Hammer pattern, like all the other technical analysis patterns, depends on the trader’s skill, experience, and ability to interpret the market sentiments. The Inverted Hammer Candlestick Pattern is also frequently observed in the case of volatile assets like cryptocurrencies. Cryptocurrencies are known for their high volatility and price fluctuations, which creates opportunities for the formation of such candlestick patterns.

At this stage, it’s good for traders to make an entry as soon as the first candle appears and put a stop-loss order at the lowest of the inverted candlestick. At this point, chances to grab maximum profits are higher as it allows traders to enter a position and place a stop-loss order at the lowest price level of the candle. Referred to as one of the efficient trend reversal tools, RSI is responsible to identify oversold or overbought in a trade and indicating possible reversals. In response, sellers try to push prices back to their original level at the time of opening and allow bulls to test the impact and reaction of the bears.

Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. You could sustain a loss of some or all of your initial investment and should not invest money that you cannot afford to lose. Well, one of the best indicators when it comes to gauging and measuring volatility, is the ADX indicators. It’s really one of those go-to solutions that we try on every strategy, in an attempt to improve performance.

Importantly, the upside price reversal must be confirmed, which means that the next candle must close above the hammer’s previous closing price. When trading the inverted hammer pattern, traders typically look to enter long positions after the confirmation candlestick closes above the inverted hammer’s high. The stop-loss can be placed below the low of the inverted hammer candlestick.

To find a bullish RSI Divergence we want to see the price on a downtrend first, making lower lows and lower highs. The idea here is to trade pullbacks to the moving average when the price is on an uptrend. Here, the worth mentioning thing is that the inverted hammer is completely different from the shooting star.

And one indicator that does a fantastic job of quantifying this, is the RSI indicator. In addition to that, it’s important to use the inverted hammer with a market and timeframe where it works well! A strict stop loss is set at the bottom price of the ‘inverted hammer’ – as clearly illustrated in the above image.

Candlestick charting techniques were further refined and expanded upon by other Japanese traders and analysts. Western traders and analysts in the 20th century began incorporating these techniques into their technical analysis methodologies. In this article, we’ve had a look at the meaning, uses, and trading strategies of the inverted hammer pattern. As such, if the market is trending up in the 240-minute chart, but down in the 5-minute chart, an inverted hammer will probably have greater odds of success. The trend on the higher timeframe signals that the market is headed up soon, and as such, what you see in the lower timeframe is a temporary pullback that has come to an end. However, an easy way to gauge the volatility of the market, is by simply watching the range of the bars.

In this article, we’re going to have a closer look at the inverted hammer pattern. We’re going to cover it’s meaning, how you spot one, some examples, and also a couple of trading strategy examples. If the market is witnessing a significant fall – even long term investors who are waiting for the ‘bottom’ of quality stocks – can take positions when such ‘trend reversal’ candles are formed on the chart. The Inverted Hammer is the 11th most frequent candlestick pattern (in terms of frequency among the 75 candlestick patterns that exist). Conversely, if it happens during a downturn in the market, it tends to be more bullish.

Price is in a downtrend as the inverted hammer’s close is below the fifty-day SMA. We see a small green candle with a tiny lower shadow and a long upper wick, giving us the upside-down hammer pattern. The Inverted Hammer candlestick pattern does provide valuable insights into potential bullish reversals, but it also has some disadvantages that traders should be aware of.

Pivot Points are automatic support and resistance levels calculated using math formulas. Since we are looking for moves to the upside, we want to trade the Inverted Hammer using support levels. The colour of an Inverted Hammer candle won’t play a major role on the upcoming forecast. With the inverted hammer identified, traditional traders go long at a break of the high and set a stop loss below the low. Now, before you trade any pattern or strategy, it’s important to validate the strategy. Now, we want the inverted hammer to occur after a downtrend, when the market is oversold.

In our own trading, we take advantage of this when we see very clear tendencies. For example, if we have a gap strategy that works terribly on Mondays ( which has been the case several times) we might not include Mondays, since the weekend gap distorts our signal too much. When the market is falling and stocks are crashing everyday – like it happened in March 2020 – a good strategy is to wait till markets stabilize.

It shows that buyers are entering at lower prices, stopping further declines and perhaps starting an upward trend. This is a major difference to the previous state of the market, where sellers dominated the scene. The increased confidence of the buyers becomes the end for the downtrend, and a bullish trend emerges shortly thereafter. To explain this more clearly, we have taken only the three candles from the above chart and marked the inverted hammer trading strategy. The Inverted Hammer candlestick pattern has a win rate of 70% in our backtests, meaning it’s pretty accurate and good at getting winners.

One common mistake traders make is ignoring the context in which the inverted hammer appears. It should occur at the bottom of a downtrend to be considered a valid bullish reversal signal. This is when the pattern appears signifying a potential change in market direction. An inverted hammer is considered a valid signal only when it appears at the bottom, indicating where the pattern is formed for it to signal a possible bullish reversal. It should be preceded by a series of bearish candlesticks, indicating a downward price movement.

If you’re looking to go bull, check out the backtest data for the best breakout candlestick patterns. There are three major differences between the patterns including the colour of the body, the position of the formation and the direction of change in market sentiment. The Inverted Hammer Candlestick Pattern is highly accurate for technical analysis. The accuracy of the Inverted Hammer candlestick pattern in technical analysis varies depending on several factors. Homma Munehisa observed that the price movements of assets were influenced by market emotions and public sentiments.

However, there much better candlestick patterns that can be labeled bullish, so we regard the Inverted Hammer as a bearish pattern. However, while the Inverted Hammer pattern can be a useful tool for traders, it may be pretty useless by itself. It must form in the right context to have any significance, which is why it must be used with tools like trendlines, support levels, moving averages, and momentum oscillators. To some traders, this confirmation candle, plus the fact that the downward trendline resistance was broken, gave them a potential signal to go long.

This material does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. You should not treat any opinion expressed in this material as a specific inducement to make any investment or follow any strategy, but only as an expression of opinion. This material does not consider your investment objectives, financial situation or needs and is not intended as recommendations appropriate for you. No representation or warranty is given as to the accuracy or completeness of the above information. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. One key concept used by many traders in the equities markets, is mean reversion.

Our backtests indicate, indeed, that the pattern is bearish when it happens in an overbought condition, meaning the market has risen recently and is perhaps running out of steam. Lawrence Pines is a Princeton University graduate with more than 25 years of experience as an equity and foreign exchange options trader for multinational banks and proprietary trading groups. In 2011, Mr. Pines started his own consulting firm through which he advises law firms and investment professionals on issues related to trading, and derivatives. Lawrence has served as an expert witness in a number of high profile trials in US Federal and international courts. If you are day trading, the Daily Pivot Points are the most popular, although the Weekly and Monthly are frequently used too. What makes a pattern valid is not just the shape, but also the location where it appears.

On the other hand, if the price does begin to rise, rewarding your recognition of the hammer signal, you will have to decide on an optimal level to exit the trade and take your profits. On its own, the hammer signal provides little guidance as to where you should set your take-profit order. As you strategize on a potential exit point, you may want to look for other resistance levels such as nearby swing lows. As with any trade, it is advisable to use stops to protect your position in case the hammer signal does not play out in the way that you expect. The level at which you set your stop will depend on your confidence in the trade and your risk tolerance. Additionally, if the bullish confirmation candlestick following the inverted hammer also exhibits high volume, it strengthens the likelihood of a sustained bullish reversal.