The popularity of candlestick charting has soared in recent years. But many traders still have questions about candlestick theory and practice. In this second of a series of articles on candlestick charting and reversal patterns we will examine the hammer. The hammer can come in a few different variations and their implications can be both bullish and bearish depending on where the hammer forms. The bearish version of the hammer is called a “hanging man” and we will look at this candle as well in this article.
The hammer and hanging man look exactly alike, but have different implications based on the preceding price action. We look for the hammer to form at the bottom of a downtrend, signaling bullish price action, possibly leading to a change in price direction. The hanging man forms at the top of an uptrend, signaling a bearish selling day letting us know that the uptrend is losing steam and may possibly turn and head south.
Hammer candlesticks form when a security moves significantly lower after the open, but rallies to close well above the intraday low. The hammer gets its name by the shape of the candle which looks like a square lollipop. The body of the hammer may be clear or filled, with the clear body being a bit more bullish. Hammers are most consistent when they occur at support in an uptrend or sideways trends. If a hammer forms near support levels, then the likelihood of a strong bullish reversal is high. The hammer must come after a prolonged downtrend. Like all candle lines, the hammer is equally potent on weekly charts, or any other time frame.
The inverted hammer appears in a market that opens at or near its low, creating a candle with a small real body. The price then moves higher in the trading day giving the inverted hammer its shadow (handle) and then comes back to close near its low. The inverted hammer is simply an upside-down hammer. What happens on the next day after the Inverted Hammer pattern is what gives traders an idea as to whether or not prices will go higher or lower. Look for confirmation, either bullish or bearish; to determine the likely direction the trend may take.
The hanging man is a bearish reversal pattern that can also mark a top or resistance level. The hanging man is a hammer that forms after an uptrend and gets its name from the way it looks on the chart…hanging at the top of a trend. Look for the hanging man to form at points of resistance on the price chart to further enhance the bearishness of the formation.
All hammer candle variations as well as the hanging man require confirmation of the next day’s candle. While these are powerful candles, many times they may only signal the weakening of the previous trend and not the actual bottom or top.