Techical Analysis N°3: Hammer Time!

June 30, 2022

Hammer is a bullish candle pattern that indicates the reversal of a downtrend move. Bears take the price to an unsustainable level where bulls try to take control. The candle’s opening and closing prices usually don’t have much difference which results in a small body of the candle which can be bearish or bullish but bullish is better. It appears after a downtrend and there should be a long lower wick on the candle at least two times equal to the size of the body.  Hammer and dragonfly candlestick patterns are almost similar to one small difference in the body of the candle. Hammer candlestick has a comparatively bigger body than the dragonfly which has small to no body at all. 

To qualify for a hammer the candle needs to fulfil the following criteria: 

  • Appears after a downtrend

  • A small candle body

  • Long lower wick at least twice the size of the candle body

  • The body of the candle can be bullish or bearish

Hammer’s lower long wick indicates the strong support and demand area of the asset. If the candle fulfils all the criteria mentioned above and the next candle gives the confirmation by closing above the last candle then you can enter in a long position or can exit from a short position but other indicators and fundamentals should also be considered in conjunction with the hammer to get the proper confirmation before executing your orders. 

Trading a hammer

Hammer can yield good profits but you need to be careful and use proper risk management to trade it as sometimes fundamentals can ruin the setup. Once you see a hammer candlestick and the next candle closes above the hammer candle, like shown in the example above, you can enter in a long/buy trade or you can also exit a short trade if you could not exit on a lower price.

Stop Loss Point

Never get complacent about stop loss, as it is very important for proper risk management while trading. You can set a stop loss below the long lower wick of the hammer candle while trading a hammer candlestick pattern.

Profit Target

Taking profit is very important and you need to always define the profit targets in advance. Profit targets can be more than one depending upon your trading style. The 1st profit target is recommended to be equal to the length of the hammer. For proper risk management, once 1st profit target is achieved you should move your stop loss to a breakeven price. You should use Fibonacci levels as well to calculate the profit targets.  You can extend your targets until you don’t see a trend reversal pattern.

Pro Tip

If you are in a short trade from above, the formation of a hammer candlestick pattern can be a good signal to exit the trade or take profits before the trend reversal.