It is difficult for a trader to make a decisive decision without critically evaluating relevant information about the market.
One of the effective tools in this decision-making process is price action trading strategies. This trading strategy usually identify market movements based primarily on the preceding price variations.
This strategy usually encompasses an array of technical analysis elements such as price band, charts, high and low swings, and trend lines.
With reference to this form of trading, a trader can adopt one of two approaches:
- On the one hand, you can choose to observe the market by relying on simple patterns like breakouts, trend lines, and price bars.
- Alternatively, you can use a detailed combination of candlesticks, channels, and volatility.
In this article, we will shift our focus to the hammer candlestick.
What is a Hammer Candlestick?
It is a price pattern that usually occurs at the lower end of a down trend. In candlestick charting, it points to a bullish reversal.
This means: the price reached new lows but closed at a higher level due to resultant buying pressure.
As part of its characteristic appearance, it has a relatively tiny body, an elongated lower wick, and a small or no upper wick. In fact, it resembles a hammer.
The prolonged lower wick signifies the rejection of the lower prices by the market.
Hammer Candle: a good or bad Trading Pattern?
Exit signal: the pattern indicates the subsidence of the selling pressure. For a trader with a short position, this is a helpful tool since it signals an apt opportunity to close on the short position.
Reversal signal: the pattern usually shows a rejection of the decreased prices.
In the event of a downtrend, the presence of this candle probably means that the selling pressure has ended and that the market may now experience a sideways or upwards trade.
Need for supporting evidence: for a trader to enter a trade with high probability, it is crucial to conduct further analysis in order to be certain about the reversal.
To do so, you can check if the hammer candle occurs close to the main level of a pivot point, support, or Fibonacci level.
You can also check if the overbought signal results from the RSI, CCI, or stochastic indicator.
How to Trade the Hammer Candlestick
Let’s take the following example of the EUR/USD to see how to use the hammer candle in the technical analysis.
The hammer candlestick is a useful tool for a trader when determining when to enter a market.
In the example above, the price reached a new low and then reversed into a higher level. The area that connects the lows is referred to as the zone of support.
It acts as a rubberstamp to the reversal signal yielded by the hammer candlestick.
As shown in the zoomed-in chart below, place the stop loss below this zone of support. As long as one maintains a positive risk-to-reward ratio, targets can be on the same level as the recent resistance level.
The chart below shows the hammer pattern on the FTSE 100 index.
Just like the price action trading strategies that we have looked at before, the hammer candlestick is a useful tool for traders. It aids one in identifying the apt time to enter a market.
However, to increase your rewards and lessen the risks, it is important to get additional information about the market through technical and fundamental analysis.