How To Trade With Hammer Candlestick Patterns?

Candlesticks are used to describe price fluctuations within a specific period of time. In the past, they were used by Japanese businessmen to record the fluctuations in the rice market. Later, they were introduced to the stock and crypto markets. K-line charts we often mention today are candlesticks.

K-line can evolve into different shapes in the long-term price trend. Special K-line shapes imply the future trend of the market. The hammer pattern is one of the typical reversal K-line patterns.

Characteristics and Changes of the Hammer Candlestick Pattern

With obvious characteristics, the hammer candlestick pattern has no distinction between red candlesticks and green candlesticks. Actually, the pattern has long lower shadows and small real bodies. The real bodies are near the top of their price range.

Figure 1

As shown in Figure 1, the length of the lower shadow of the hammer candlestick pattern is at least twice the height of the real body. The longer the lower shadow and the smaller the real body, the more reliable this pattern is. In general, this kind of K-line should have no upper shadow line, even if it has an upper shadow line, the length is extremely short (as shown in Figure 2).

（Figure 2）

In extreme cases, the hammer candlestick pattern will evolve into another special K-line. Similar to the letter “T”, this pattern is called the T-line and is known as the dragonfly line. The length of its lower shadow line is also twice its entity (as shown in Figure 3).

（Figure 3）

Through the above-mentioned three hammer candlestick patterns, we can make summarize some points to identify them:

1. The entity has no color distinction, and the closing price is at the upper end of the entire price range.

2. The length of the lower shadow is more than twice the height of the real body.

3. The pattern has no upper shadow line. Even if there is, it is extremely short.

Significance of the Hammer candlestick pattern

The hammer candlestick pattern indicates that the price rises after a large drop, gradually reducing the price drop, while the fluctuation becomes larger. It means that a large number of funds are put into the market, and there will be major changes in the market outlook.

In a long-term downtrend, if a hammer appears, it will indicate that the downtrend is coming to an end. At this time, the pattern is a relatively reliable bottom shape (as shown in Figure 4).

（Figure 4）

After a sharp rise in the market, the appearance of the hammer line indicates the rising momentum will be weakened, and it is about to reach its peak. At this time, the hammer line is also called the “hanging line” because it hangs at a high level (as shown in Figure 5).

Trading Strategy for the Hammer Candle Pattern

Now that you can identify the hammer candlestick pattern, you need to learn to seize the best trading opportunity at the hammer line.

Trading strategies in a down market

As shown in the figure above, the hammer candlestick pattern appears in the falling market. It is a signal that the market is about to reverse. When the K-line after the hammer line breaks through the high point of the hammer line, its closing price is the first buying point A. When the price falls to the vicinity of the hammer entity again, the second buying point B comes.

Examples

Let’s take the daily K-line of ETH/USDT on the Gate.io platform as an example: On February 27, 2021, after ETH went through a period of decline, a hammer K-line appeared. On the following day, a red candlestick formed. It was above the entity of the K-line of the hammer and even broke through the high point of the previous K-line, which is a relatively strong sign that the price has bottomed out and is about to rise. Investors can choose to buy at the end of the K-line of the next day. When the price steps back on the entity of the hammer K-line again, it will form the second buying point B.

Trading Strategies in a Rising Market

We can see from the figure above that a hammer candlestick pattern appears in the rising market, and the following K-line fails to break through the high point of the hammer line. Instead, it falls to the entity of the previous K-line of the hammer line and forms the first selling point A. After the price falls below the lower shadow line of the hammer line and rebounds to near the lower shadow line of the hammer line again, the second selling point B comes.

Example

Here we take the daily K-line of ETH/USDT on the Gate.io platform as an example: on September 11, 2022, a hammer candlestick pattern appeared at the high point of a rising market, and the closing price was below the closing price of the previous K-line, which is a sign that the rising momentum is weakened and the selling pressure is increasing. The subsequent K-line closed a green K-line with a long body and fell below the lower shadow line (the lowest price) of the hammer line. Therefore, the hammer candlestick can be regarded as a strong top reversal signal, and investors should be cautious if they want to enter at the high point.

Notes

To judge whether there will be a reversal trend in the hammer candle pattern, we need to use other criteria to verify the trend reversal signal, thus avoiding the trap of the hammer candlestick pattern.

1. After the hammer candlestick appears in a down market, the closing price of the following candlestick is higher than the closing price of the hammer K-line.

2. Before the hammer candlestick, there must be a downward trend, and on the day when the hammer candlestick signal appears, the trading volume is relatively large. If so, it is more likely that the hammer candlestick will reverse the downward trend.

3. In a rising market, the hammer candlestick reaches a new high. The following K-line fails to break through the peak of the hammer candlestick and closes below the body of the hammer candlestick. More importantly, it drops below the lower shadow line of the hammer candlestick in the subsequent falling market. If so, it is a sign of a bear market.

Conclusion

In technical analysis, the hammer candle pattern is regarded as one of the typical reversal K-line signals. However, the “reversal” in the technical analysis does not mean that extreme changes will occur immediately.

Usually, the appearance of a trend reversal signal means that the previous market trend may change, but it does not necessarily reverse in the opposite direction. The real trend reversal often happens slowly over time and will be affected by the gradual change of market psychology. That’s to say, it is a slow evolution. Therefore, we can only use it as an auxiliary means to judge the trend, and cannot use it as a simple trading strategy.