Inverted Hammer pattern indicates a possible bullish reversal after a strong downtrend. The main idea is that the bearish momentum is getting exhausted at some price level as put-option buyers cannot absorb the buying pressure and the candle has a long upper shadow with a comparatively small body and little to no downside shadow. The formation is used in one context only and it is not a trading signal itself because an additional confirmation is required.
Japan traders made lots of observations and conclusions when they were learning the price action with candlesticks view in the 18th century. The main advantage of Japanese candles is that they show four prices for a particular period - open, high, low and close (OHLC). This feature is much more useful for the graphical analysis compared to the single line on the price chart as traders can get comprehensive information about the price action within the given period at first glance. Some of the technical indicators can also apply their mathematical formulas to the set of OHLC prices or to any of them. This makes the technical analysis more flexible, offering a wide variety of options to build a profitable trading system and automated algorithms.
What is an Inverted Hammer Candlestick?
Inverted hammer candlestick appears on the price chart after a sustainable downtrend and it points to a potential bullish reversal. The candle has a long upper shadow and small body with little or no downside shadow. The length of the downside shadow has to be at least twice as large as the body size.
The pattern looks like this:
What does Inverted Hammer mean?
Inverted hammer candle describes a price action when the bulls are trying to reverse the previous downtrend. The body colour of the candle does not matter as the main requirement is the ratio between the shadow and body. Long shadows traditionally mean a strong resistance or support level in the sense that buyers are ready to fight for a certain price level, while the sellers cannot push the price through it. Although the bulls cannot reverse the downtrend in a single action because of the volume of offers for the asset is still large, the buying momentum grows compared to previous candlesticks, which could or could not mean a possible reversal of the downtrend. If the next candle after the inverted hammer bullish pattern appears in the green, then the likelihood of the trend’s reversal is getting higher.
What is the difference between the inverted hammer and hanging man?
Both candlestick formations look identical but the difference is in the context. The inverted hammer candle reverses the downtrend and further price action is headed north. In contrast, the hanging man is aimed to show a bearish reversal after a sustainable downtrend.
How to use an Inverted Hammer Candlestick?
There are two possible ways to use the Inverted Hammer candlestick pattern depending on the timeframe and expiration time of binary options trade are keen on opening. The first way is to trade on the same chart as the analysis is made. The second way is to make an analysis and decisions on a larger timeframe but start buying binary options with shorter expiration time. Before we’ll have a closer look at both of them, we have to describe all of the conditions to enter the market.
Conditions to buy CALL options on inverted hammer candlestick pattern
- A sustainable downtrend has to be noticed with at least three candlesticks in the red and the sequence of lower lows and lower highs;
- If the inverted hammer appears on the price chart after a strong downtrend, traders should get ready to start the trading cycle and watch the next candle;
- If the following candle closes in the green and above the inverted hammer’s open, then traders should start buying call options on the next candle open;
- Traders should continue the cycle of buying call options if the price action goes in the right direction as the sequence of higher highs and higher lows are in place;
- Traders should stop the trading cycle if one of the following bars closes below the lowest value of the inverted hammer.
Binary options could consider such a scenario that they open one or two deals after the inverted hammer was confirmed, and stop the cycle after that. The main concern is that the pattern does not guarantee the depth of a possible bullish rebound as it only shows that a reversal or retracement is possible. Sometimes it happens that the underlying asset charts a couple of green candles and gets into a sideways consolidation with directionless action.
[bh3]Buying call options after the inverted hammer candle on a shorter timeframe[/b]
An alternative scenario is that traders make the analysis on a larger timeframe but start opening deals with shorter expiry. For example, if the inverted hammer pattern was confirmed on a daily chart, traders could start buying call options with 4- or 1-hour expiration time. The only requirement, in this case, is that the trading has to be executed during active hours of trading sessions. Additional technical analysis on shorter time frames would be a plus.
If you like this strategy, you might also be interested in this: Hammer Candlestick
Example of profit trades using
As far as the pattern is just a preliminary trading signal and requires confirmation, every particular case has to be considered separately depending on context and trading conditions. Here are several examples of profitable trading on binary options.
Buying CALL options for GBP/USD
The four-hourly chart below shows the GBP/USD currency pair in a sustainable downtrend on November 8, 2019. After the exchange rate dropped to 1.2770, the bulls started entering the market and charted the inverted hammer candle, signalling a strong support level. After the pattern was confirmed, traders could start buying call options and three consecutive bars were in the money
Buying CALL options for USD/CHF with 24-hours expiration
The daily chart of USD/CHF below has two examples of inverted hammers. In the first case, the pattern was confirmed by the following daily candle and the trading cycle of buying call options was profitable. However, the second case does not have a confirmation by the next candle, so the signal must be ignored.
Buying call options with shorter expiration
The chart below uses the same example as the previous daily chart of USD/CHF. After the signal to buy call options was confirmed on the daily timeframe, the following bar ( had such a price action as shown on the screenshot. Active trading hours during the European trading session started with the bullish rally, so binary options traders could take advantage of buying call options with 60-minutes expiry after the signal on the daily timeframe. As a result, 7 deals out of 8 were in the money.
Inverted Hammer candle is widely used in the technical analysis to find reversal points of a downtrend. This is a single-candle pattern, thus, it requires an additional confirmation. The formation appears on any chart period and asset, so the trading strategy is flexible and simple. The analysis could be made on a longer timeframe while the trading could be executed with shorter expiration time.