Inverted Hammer Candlestick

Inverted Hammer Candlestick Pattern Meaning

An inverted hammer candlestick refers to a technical analysis chart pattern that typically appears on a price chart when buyers in the market generate enough pressure to drive up an asset’s price. Usually, one can find it at the end of a downward trend; it signals a potential bullish reversal.

This candlestick pattern features a short body and an upper shadow or wick that is more than twice as large. Note that this candle has a very small or no shadow at the bottom. Thus, as the name suggests, the shape resembles an upside-down hammer. This candlestick can be of two types — bearish or red and bullish or green.

• Inverted hammer candlestick refers to a candlestick chart formation that one can find at a downtrend’s end. It gives the signal of a potential reversal in the trend of the financial asset. 
• There are two kinds of inverted hammer candles — green and red. A green candle signifies a bullish reversal, while a red inverted hammer is a bearish continuation pattern.
• A key benefit of an inverted hammer candlestick is that even a novice trader can identify the pattern easily.
• A noteworthy difference between shooting star and inverted hammer candlesticks is that the latter indicates buying pressure, unlike the former.

Inverted Hammer Candlestick Pattern Explained

The inverted hammer candlestick refers to a candlestick pattern appearing on a financial instrument’s price chart when buying pressure in the market moves the asset price upwards. It is a sign of a reversal following a downtrend and thus can assist people carrying out technical analysis to identify trend reversals. Such a candle’s upper wick indicates that buyers drove up the price, defeating the sellers who tried to push the price downwards.

As noted above, the lower shadow or wick of such a pattern is either extremely small or simply non-existent. This denotes the sellers’ resistance toward higher prices and their attempt to bring the price down, but the bulls did enough to ensure that the close was at a higher price level. The surging volume indicates increasing buying activity and supports the pattern’s potential bullish reversal.

A red or bearish hammer candle shows that sellers took charge and drove the price back downward despite buyers’ efforts. Generally, analysts view it as a bearish continuation candlestick pattern. On the other hand, a green or bullish hammer is a bullish reversal sign. It denotes buyer strength and a potential shift in momentum.

Typically, these patterns appear less frequently in long timeframes than in short timeframes. This is because a continuous downtrend’s occurrence is more common in the case of the latter.    

Chart

Let us look at an inverted hammer chart from TradingView below to understand the concept better.

Source

In the above price chart of Hero MotorCorp Limited stock, we can see that a green inverted hammer candlestick appears at the end of a downtrend, signaling strong buying pressure from the bulls in the market. The pattern indicates a potential reversal in the trend. After taking into account the trading volume, which has increased as shown in the chart, one can place a buy order to benefit from the likely upward trend.

In the chart, it is suggested that individuals purchase the stock above the inverted hammer’s high. Also, it recommends placing a stop loss under the preceding red candle’s low to prevent significant losses.

How To Trade?

Let us look at some key pointers to trade this candlestick pattern.

1. Confirmation

First, one must confirm the pattern. For that, they need to keep this thing in mind:

• Verify that the upper wick’s length is two times the size of the candle’s body.
• If the candle’s formation takes place with a gap down with respect to the candlestick of the previous day, there is a higher chance of a trend reversal occurring.
• Note that analyzing the trading volume of a financial instrument is crucial to confirm such a pattern’s structure. As this pattern develops, traders usually look for an increase in trading activity. High trading volume denotes that buyers are exerting pressure to drive up the financial instrument’s price.

Also, traders should consider entering a buying position the following day if the opening price of the security is higher.

2. Consider The Psychology Concerning The Pattern

The prior price trend must be a downward trend to make the most of this pattern. When a green inverted hammer candle’s formation takes place, it demonstrates that the bulls have made a comeback and the bears cannot drive the price down. If the strength of the financial instrument’s price remains in the following trading session, one can consider buying the security.

3. Avoid Confusion

Traders must ensure not to confuse this candlestick with other patterns, like the shooting star.

If individuals identify such a pattern, they must remember that an uptrend may or may not materialize. They must pair the chart pattern with other indicators, for example, a confirmation candle or a trendline break, and never solely rely on it.

Also, one must ensure to utilize some effective risk management methods to prevent losses in case of the reversal’s failure. These techniques typically depend on one’s risk appetite and position size.

Examples

Let us look at a few inverted hammer candlestick examples to understand the concept better.

Example #1

Suppose Jack is a trader in the stock market. He had ABC stock on his watchlist for more than a week. He looked at the stock’s price chart daily. After noticing a bullish inverted hammer candlestick at the end of a downward trend, he witnessed that the trading volume increased significantly. Jack believed there was enough buying pressure to increase the price.

Hence, predicting an uptrend, he bought 100 shares above the high of the inverted hammer candle at $8 per share. The next day, he sold the shares at $12 per share and pocketed a total profit of $400.

Example #2

In August 2023, once initial buzz concerning the partial legal victory of Ripple Lab against the United States Securities and Exchange Commission subsided, there was a decline in XRP price, leading to the test of the digital asset’s four-month support line. That said, the cryptocurrency showed resilience as it reentered the prior accumulation or consolidation zone. The renewed stability sparked a great deal of optimism among the bullish investors, signaling a likely reversal for the digital asset.

As the two-month candlestick for the cryptocurrency drew to a close, it displayed an inverted hammer candlestick’s potential formation. This showed that the cryptocurrency was poised for a significant increase in price.

Advantages And Disadvantages

Let us look at the benefits and limitations of the inverted hammer candlestick pattern.

Advantages

• One can easily spot this pattern in a price chart because of its distinct features, like a short candle body and a wick twice its size. Also, the little or no wick at the bottom makes it even more identifiable for any new trader.
• Traders can use it with other indicators or patterns to enter a buying position early. As a result, they can earn significant returns after an uptrend materializes.
• A key advantage of this pattern is that it is applicable to different timescales.

Disadvantages

• It may indicate a trend reversal, but the uptrend may not last long if the buyers cannot maintain their strength.
• The pattern provides a limited view concerning the market behavior. Simply depending on it may lead to losses.

Inverted Hammer vs Shooting Star

The key differences between a shooting star and inverted hammer candlesticks are as follows:

• A shooting star candlestick appears at the top of an upward trend. On the other hand, an inverted hammer appears at the bottom or end of a downward trend in financial markets.
• An inverted hammer indicates a bullish reversal, while a shooting star is a bearish reversal signal.
• A shooting star candlestick denotes potential selling pressure. On the other hand, an inverted hammer candlestick generally denotes potential buying pressure.

Frequently Asked Questions (FAQs)

Recommended Articles

This has been a guide to Inverted Hammer Candlestick and its meaning. We explain its chart, how to trade it, & comparison with shooting star candlestick. You can learn more about accounting from the articles below –

• Continuation Pattern
• Hanging Man Candlestick
• Hammer Candlestick