Inverted Hammer Candlestick Pattern: Technical Analysis and Trading Guide
Inverted Hammer is a popular single candlestick pattern. It is a bullish candlestick pattern and it generally indicates a bullish reversal. Inverted Hammer candlestick is used by many traders as a part of an overall trading system.
Traditionally this is used as a bullish reversal pattern but the right way to trade it is actually different. We will see the correct usage of inverted hammer at the end of this article which has more than 60% success rate.
Let’s get through the traditional information first.
Here are some key takeaways for Inverted Hammer candlestick pattern
- It is a bullish candlestick pattern (bullish reversal to be precise)
- It occurs with medium to high frequently
- It can occur in both uptrend and downtrend
- It is not used for trading on its own
- It has good success rate (If used correctly!)
What is Inverted Hammer Candlestick Pattern:
The Inverted Hammer candlestick is one which has small real body and a long upper shadow or wick. Inverted Hammer candle generally has a small but nonzero real body . It has an upper shadow or wick which is two to three times the size of the real body and it has no or very small lower shadow.
The colour of the candle is not significant and can be green or red. It generally occurs at the end of a downtrend suggesting a possible reversal. It can also occur at the end of a retracement in an overall uptrend.
Is an inverted hammer bullish or bearish?
An inverted hammer candlestick pattern in traditional analysis is actually bullish reversal pattern. However, a more correct way to use it is presented in the encyclopaedia of candlestick charts and it is bearish continuation in nature. It has far more chance of success than the bullish reversal method.
We will see it in more detail later.
What Does the Inverted Hammer Candlestick Look Like?
An Inverted Hammer candlestick looks like what the name suggests !! , an inverted Hammer. Below picture shows various versions of an Inverted Hammer candlestick.
There are main 2 versions , both share the same core construction but differ in who won the battle at the end of the timeframe.
Though the Inverted Hammer candlestick pattern is always considered as a sign of bullish reversal, the candle can be green or red in colour. The colour is not considered important for the interpretation.
The Inverted Hammer should have very small or NO bottom shadows.
What does Inverted Hammer candlestick pattern mean?
For a daily candlestick chart , an Inverted Hammer candlestick will indicate the battle between bulls and bears in following way.
- The price opened at a particular point , during the trading day, the bulls are dominant and force price much higher.
- By the day’s end however , the bears have managed a recovery by pushing price back down.
- The bears may manage to recover the price completely and closing price may end up lower than the opening price. This makes the candle red.
- In case , the bears do not manage to close the price below the open then the candle will be green.
- In both the above cases , the battle on that day was won by bulls as they showed a sense of resistance in prevalent downtrend and hence this pattern is always considered as bullish independent of the colour of the candle.
A green Inverted Hammer candle, however, is slightly more bullish compared to a red Inverted Hammer candle.
Inverted Hammer Bullish Reversal
Inverted Hammer candlestick in a downtrend generally occurs after a sharp fall. It can also occur after a gradual fall but chances of Inverted Hammer occurring after a sharp fall are more due to the nature of the market.
Inverted Hammer candlestick after a prevalent downtrend can mean two things, it can mean a reversal into an uptrend. This can only be confirmed if the price closes above the high of the hammer. This can take anywhere between 2 to 8 days (or timeframes you are looking at)
It can also mean a small retracement or profit booking (this is experienced more than the actual reversal). The price on following days will go down again and if it breaks down below the low of the Inverted Hammer then one can take a trade on short side. This generally takes 2 to 9 trading days or timeframes you are looking at.
Examples of How to Trade Inverted Hammer candlestick pattern: Inverted Hammer trading strategy.
The Inverted Hammer candlestick pattern is generally used to identify reversal from a prevailing downtrend. However, hammers actually work better with retracements rather than reversals and inverted hammer works even better as a bearish continuation. We will see this in detail soon.
Trading Inverted Hammer pattern in uptrend :
The best-performing hammers are those that occur during a downward retracement of the primary (longer-term) upward trend. Once an Inverted Hammer is formed during a retracement in a primary long-term uptrend, one should wait for the high of the Inverted Hammer to be broken before entering a trade.
Inverted Hammer candlestick pattern cannot be traded on its own and it needs additional information and confluence of other resistance regions such as previous support and resistance , moving average or Fibonacci levels.
An Inverted Hammer candle especially a green Inverted Hammer at the end of 38.2% or 50 % Fibonacci retracements works better than others. Stop loss can be placed at the base of the Inverted Hammer or a previous low.
An Inverted Hammer candle wick rejecting a significant moving average is probably the best place to trade using an Inverted Hammer candlestick pattern.
Trading Inverted Hammer pattern in downtrend :
In case of a Inverted Hammer occurring in a prevalent downtrend then one should look for a long green ( White ) candle after a Inverted Hammer( also known as engulfing ), this indicates that the buyers were able to outperform sellers on two consecutive timeframes, this has a very good chance of reversal.
Trading Inverted Hammer pattern in downtrend is very difficult as you are trying to pick the market bottom which happens very rarely and 9 out of 10 times you will be wrong.
One must use other reversal signals such as momentum reversal , long-term trendline break , oscillators coming back from oversold regions and another suitable price action etc.
The main use of inverted hammer is actually bearish continuation and we will see it in detail later.
Using Inverted Hammer as support level :
A long wick Inverted Hammer which successfully resulted into a trend reversal is also considered as a very good support level. Price coming back to this level in future is likely to be rejected again.
Inverted Hammer occurring along with a spinning top or even multiple hammers together also increases the chance of Inverted Hammer to work.
While using Inverted Hammer candle as support level, one should be using the bottom of the wick and not the real body of the candle.
Limitations of Inverted Hammer Candlestick Pattern:
There are 2 main limitations of using Inverted Hammer candlestick pattern.
- Depending on the length of the top shadow , if one takes a trade after a breakout of the high of the Inverted Hammer, the stop loss distance is very high. Sometimes the top wick of the Inverted Hammer is very long, and it makes practically impossible to take a trade with such a large stop loss.
- Second main disadvantage of the Inverted Hammer is that, it does not indicate anything about a possible price target if the trade goes in your direction. One generally has to go with a 1 : 1 or 1 : 2 risk to reward ratio depending upon the length of top wick.
Correct Way to trade using inverted Hammer : Bearish continuation pattern
The inverted hammer if used in a two-candle pattern version as a bearish continuation pattern works far better that the traditional bullish reversal system.
As per encyclopedia of candlestick charts : The first surprise with the inverted hammer is that it acts as a continuation more often than a reversal, despite convention saying otherwise. The second surprise is that sources I checked on this pattern cannot decide what the configuration is. One source says, “The upper shadow should be at least two times the length of the body,” while another says, “Upper shadow [is] usually no more than twice as long as the real body.” Of the six independent sources I checked, three said the shadow should be shorter than twice the body and three said it should be longer. No wonder candlesticks are subject to interpretation; few can agree on what they should look like.
When I thought of an inverted hammer, I guessed that it was a single candle line, a hammer candle flipped upside down. It’s not, according to numerous sources I checked, but some suggest it’s a single candle line. I tested the two-line variety. The candle pattern begins in a downtrend. The bears form a tall black candle followed by a small body with a long upper shadow. It appears near the low of the black candle. The small body suggests indecision, but the tall upper shadow means a bearish downward thrust. With price continuing lower two-thirds of the time, the markets seem to agree with my assessment.
The overall performance rank of the candle pattern is 6 out of 103 candles where 1 is best. Thus, this is one of the best-performing candles. Even such strong performance has its peculiarities, though. The inverted hammer performs better after an upward breakout, not a downward one.
|Number of candle lines||Two|
|Price trend||Downward leading to the candle pattern.|
|First day||A tall black candle with a close near the low of the day.|
|Second day||A small-bodied candle with a tall upper shadow and little or no lower shadow. Body cannot be a doji (otherwise it’s a gravestone doji). The open must be below the prior day’s close. Candle colour is unimportant.|
The above pattern has a lot more success rate when traded on the sell side. For the best performance from this candle, trade it only in a downward retracement of the primary uptrend. Price breaks out upward from the candle pattern, and the existing current pulls price along to higher ground. You want to avoid depending on this candle acting as a reversal of the primary downtrend, because there the chances are that price will move up but not for long.
An aggressive trader can enter at the high of the inverted hammer on the sell side which gives best risk to reward ratio but also has a high risk associated with it as you are not sure if the original downtrend will continue.
A conservative trader can enter on next day if the price goes below the close of the first candle of the pattern or open of the inverted hammer.
Inverted Hammer vs Hanging Man Candlestick Pattern
The basic nature of the candle in both Inverted Hammer and Hanging man is similar. Both consist of a small real body and a long shadow or wick. Main difference is that in case of a hanging man the wick or shadow is at the bottom while in inverted hammer it is at the top. Both of them also indicate a reversal.
The main difference is the market precedence when these patterns occur. Inverted Hammer occurs during a downtrend or a retracement during a prevalent uptrend indicating a bullish reversal , whereas a hanging man occurs at the end of an uptrend indicating a bearing reversal.
Though the nature or look of the candle is same , the meaning is completely different, and one must be careful in using it in their trading plan.
You can learn more about Hanging man candlestick pattern here.
Hammer vs Inverted Hammer Candlestick Pattern
Hammer and inverted hammer both are traditionally used as bullish reversal patterns at the end of a downtrend. Both hammer and inverted hammer have a small real body. Hammer has long bottom shadow , whereas inverted hammer has long top shadow.
Both occur at the ne end a downtrend or at the end of a retracement in a prevalent uptrend. Hammer pattern appears more often than inverted hammer. Inverted hammer is more accurate than hammer if traded correctly i.e as a bearish continuation.
Hammer on the other hands works better in prevalent uptrend at the end of a retracement.
Is an Inverted Hammer the same as a Shooting Star?
In isolation both patterns look similar. Both have the same candle construction of a small body and a long top wick or shadow.
The main difference lies in the fact that the shooting star appears at the end of uptrend while an inverted hammer appears at the end of a downtrend.
Shooting star is traditionally used as a bearish reversal and inverted hammer is used as a bullish reversal. Inverted hammer can also be used as a bearish continuation pattern.
Read more at: https://commodity.com/technical-analysis/inverted-hammer/
Associated Candlestick patters :
Doji , Spinning top , Harami , Shooting star , Evening star , Hammer , Inverted Hammer