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Hammer Candlestick

One of the Japanese Candlestick Patterns is called a Hammer. This is a single-candle pattern reflectinteg a failed atmpt of sellers to push the price lower and a counter-trend bounce from a support level because of strong demand for the underlying asset from the side of call-option buyers. In other words, the pattern might show the trend’s reversal.

The name of the pattern reflects its shape in terms of how it looks like. It has a small body and a long downside shadow. The length of the lower shadow has to be twice as much as the size of the body.

The colour of the body does not matter as the main condition is that the close price has to be near the open.


Hammer candlesticks are used to find reversal levels where the downtrend is getting exhausted or losing momentum. At the same time, the pattern can show price levels attractive for call-option buyers to enter the market. For example, if the underlying asset was in a heavy sell-off and it reached an extremely low price compared to the long-term average value, buyers could find that quote attractive for long-term investments. Let’s have a look at the details of a trading strategy based on hammer candlestick.

Hammer Candlestick Chart Example


Hammer candlestick pattern consists of a single candle with a long lower shadow and small body.

Here is how it looks like:

Hammer Candlestick

Japanese candlesticks are much more useful in terms of visual analysis of the price action. In contrast to the traditional line on the price chart, candles have four prices represented on the graph - open, high, low and close quotes (OHLC). This feature allows traders to analyse the price action within the chosen period.

Regardless of the trend’s direction, every candle with a long shadow shows that the fight between the bulls and bears is getting tougher. Long shadows also point to higher volatility compared to the previous period. In case of sellers lose the momentum or strength to push the price lower constantly, buyers step in and reverse the trend. As a result, a long shadow appears on the candle.

Every single-candle pattern has to be considered in a context. For example, in a ranging market with directionless action, a candlestick with a long shadow does not reverse anything as it only points to a strong support or resistance level. Thus, it cannot be taken as a trading signal to start buying a call or put options, respectively. However, if a long-shadowed bar appears after a strong downtrend, the bullish reversal is likely, although it requires confirmation.

Types of hammer candlesticks


Depending on the bodys colour, there are two types of pattern:

  1. Bearish hammer candlestick - indicates that despite the counter-trend action, sellers managed to close the bar lower than the open price.
  2. Bullish hammer candlestick - shows that buyers were able not only to reverse the trade conditions but also closed the period higher than the open rate.

Difference between Hammer and Doji candle


Doji candles also have long shadows. But the difference between Hammer candle and a Doji is that hammers have a larger body, indicating a reversal, while Doji reflects the market uncertainty. Nevertheless, both single-candle patterns require confirmation by the next bar.

What does a hammer candlestick mean?


When an asset price is in a sustainable downtrend, the sequence of lower lows confirms the strong demand for put options. Close rates near the low indicate that sellers are strong, pullbacks are tight and the bearish continuation is likely. On the other hand, if the close rate bounces far from the low, charting a long downside shadow, then it means that the sellers were unable to hold previous achievements and were forced to retreat because of strong demand for call options. In this case, further trend’s direction could change in case if the signal confirmed by the following candlestick. The opposite price action, trend reversal or at least a consolidation period has a higher likelihood.

Another example of a bull hammer candle is related to the context of the previous uptrend. Imagine that prices were moving north in a stable uptrend, charting several green candles with close prices near the highs. At some point, sellers were trying to reverse the uptrend, pushing the quote much lower than the open price. However, buyers were still strong enough to reverse the intraday action and close the day near its open. Despite the bullish result of the bar, a change in the trend’s direction could happen as the sellers showed their strength at this particular level. Binary options traders should keep in mind that additional confirmation is needed before opening deals.

How to use Hammer candlesticks?


Candlestick hammer meaning suggests a reversal of the previous downtrend. The chart tool is used to determine moments when a downtrend is getting weaker and the likelihood of a reversal is getting higher. However, the pattern is just a preliminary signal and the next candle’s colour is crucial in terms of entering the market. Here are the main rules of the trading strategy based on Hammer candlestick patterns.

Conditions to buy CALL options:

  • If a downtrend with at least three bearish bars was noticed and a hammer candlestick appeared, binary options traders should get ready for a trading cycle.
  • If the following candle was in the green (bullish), traders should start buying call options on the next bar’s open.
  • The trading cycle has to be continued if the market is moving in the right direction and further candles keep charting higher highs.
  • In case if the asset price dropped lower than the low rate of the hammer candle, traders should stop the trading cycle of buying call options.

Conditions to buy PUT options:

  • If an uptrend with at least three bullish bars was noticed and a hammer candlestick appeared, binary options traders should get ready for a trading cycle.
  • If the following candle was in the red (bearish), traders should start buying put options on the next bar’s open.
  • The trading cycle has to be continued if the market is moving in the right direction and further candles keep charting lower lows.
  • In case if the asset price jumped higher than the high rate of the hammer candle, traders should stop the trading cycle of buying put options.


If you like this strategy, you might also be interested in this Vortex Indicator
Timeframes and expiration time

There is a trading method that suggests the analysis on a longer timeframe but trading on binary options with a shorter expiration time. For example, if a hammer candle signalled the downtrend reversal on the daily chart, traders could start buying call options with 6-minutes expiration time. There are two requirements for this option. First, traders should choose the most active hours of the trading session when the volume is high. Second, in case if the rate went below the hammer candle’s low, traders should stop buying call options.

Examples of using


The daily chart below shows the reversal pattern of the AUD/USD currency pair. After a clear downtrend, the hammer (candlestick pattern) pointed to a possible reversal, while the following candle confirmed the signal to start buying call options. After a short-term retracement, another hammer was charted, signalling further uptrend and giving the chance to keep buying call options.

Hammer Candlestick

Here is another example of using candlestick hammer in binary options trading. GBP/USD was declining but the strength of the downtrend was lowering. As a result, the hammer candle pointed to the start of the bullish action. Although the body of the hammer was not that small, the long lower shadow leads to three consecutive candlesticks in the green.

Hammer Candlestick

Using candlestick hammer together with oscillators

An additional indicator could be useful in the scope of confirmation of the trading signal received from a hammer candle. An example below shows that Stochastic RSI performed a bullish crossover in the oversold territory after the hammer candlestick appeared on the price chart. That was an additional confirmation to start buying CALL options. The following price action shows that the USD/CHF currency pair reversed and started moving north after the double-signal.

Hammer Candlestick

Conclusion


Hammer (candlestick pattern) is a reversal pattern used in the graphical and technical analysis. The long lower shadow of the candle points to strong support or resistance and the weakness of the previous trend. In most cases, the hammer candle is used to show the bullish reversal after a sustainable downtrend. However, some applications suggest a bearish reversal after the hammer pattern. As long as this is a single-candle pattern, it requires an additional confirmation by the following bar or technical indicators.


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