Hammer Candlestick Patterns: A Trader’s Guide
Source: Daily FX
Trading with the Hammer Candle: Main Talking Points
The hammer candlestick pattern is frequently observed in the forex market and provides important insight into trend reversals. It’s crucial that traders understand that there is more to the hammer candle than simply spotting it on a chart. Price action and the location of the hammer candle, when viewed within the existing trend, are both crucial validating factors for this candle.
This article will cover:
- What is a hammer candle pattern?
- Advantages and limitations of the hammer chart pattern
- Using a hammer candlestick pattern in trading
- Further reading on trading with candlestick patterns
What is a Hammer Candlestick?
The hammer candlestick is found at the bottom of a downtrend and signals a potential (bullish) reversal in the market.The most common hammer candle is the bullish hammer which has a small candle body and an extended lower wick – showing rejection of lower prices.The other pattern traders look out for is the inverted hammer, which is an upside-down bullish hammer.
Bullish Hammer Candlestick
The hammer candlestick appears at the bottom of a down trend and signals a bullish reversal. The hammer candle has a small body, little to no upper wick, and a long lower wick – resembling a ‘hammer’.
The pattern indicates that the price dropped to new lows, but subsequent buying pressure forced the price to close higher, hinting at a potential reversal. The extended lower wick is indicative of the rejection of lower prices.
Advantages and Limitations of the Hammer Candlestick
Hammer candles have their advantages and their limitations; therefore, traders should never rush into placing a trade as soon as the hammer candle has been identified.
- Reversal signal: The pattern indicates the rejection of lower prices. When found in a downtrend it could signal the end of selling pressure and begin to trade sideways or reverse to the upside.
- Exit signal: Traders that have an existing short position, can viw the hammer candle as an indication that selling pressure is subsiding – presenting the ideal time to close out of the short position.
- No indication of trend: The hammer candle does not take the trend into consideration and therefore, when considered in isolation, can provide a false signal.
- Supporting evidence: In order to enter into high probability trades, it is important for traders to look for additional information on the chart that supports the case for a reversal. Such confluence can be found by assessing whether the hammer appears near a major level of support, pivot point, significant Fibonacci level; or whether an overbought signal is produced on the CCI, RSI or stachastic indicator.
Using Hammer Candles in Technical Analysis
The following example of how to trade the hammer candlestick highlights the hammer candle on the weekly EUR/USD chart.
Traders can make use of hammer technical analysis when deciding on entries into the market. Looking at a zoomed-out view of the above example, the chart shows how price bounced from newly created lows before reversing higher. The zone connecting the lows acts as support and provides greater conviction to the reversal signal produced by the hammer candlestick.
Learn more about Trading with Hammer Candles
- If you are just starting out on your trading journey it is essential to understand the basics of forex trading in our New to Forex trading guide.
- The hammer candlestick is just one of many candlestick patterns that all traders should know. Improve your knowledge by learning the Top 10 Candlestick Patterns.
- For more information on reversal patterns, read our article on Trading the Bullish Hammer Candle.
Shooting Star Definition and Applications
Reviewed by Cory Mitchell Updated Apr 19, 2019
What is a Shooting Star?
A shooting star is a bearish candlestick with a long upper shadow, little or no lower shadow, and a small real body near the low of the day. It appears after an uptrend. Said differently, a shooting star is a type of candlestick that forms when a security opens, advances significantly, but then closes the day near the open again.
For a candlestick to be considered a shooting star, the formation must appear during a price advance. Also, the distance between the highest price of the day and the opening price must be more than twice as large as the shooting star’s body. There should be little to no shadow below the real body.
- A shooting star occurs after an advance and indicates the price could start falling.
- The formation is bearish because the price tried to rise significantly during the day, but then the sellers took over and pushed the price back down toward the open.
- Traders typically wait to see what the next candle (period) does following a shooting star. If the price declines during the next period they may sell or short.
- If the price rises after a shooting star, the formation may have been a false signal or the candle is marking a potential resistance area around the price range of the candle.
What Does the Shooting Star Tell You?
Shooting stars indicate a potential price top and reversal. The shooting star candle is most effective when it forms after a series of three or more consecutive rising candles with higher highs. It may also occur during a period of overall rising prices, even if a few recent candles were bearish.
Following the advance, a shooting star opens and then rises strongly during the day. This shows the same buying pressure seen over the last several periods. As the day progresses, though, the sellers step in and push the price back down to near the open, erasing the gains for the day. This shows that buyers lost control by the close of the day, and the sellers may be taking over.
The long upper shadow represents the buyers who bought during the day but are now in a losing position because the price dropped back to the open.
The candle that forms after the shooting star is what confirms the shooting star candle. The next candle’s high must stay below the high of the shooting star and then proceed to close below the close of the shooting star. Ideally, the candle after the shooting star gaps lower or opens near the prior close and then moves lower on heavy volume. A down day after a shooting star helps confirm the price reversal and indicates the price could continue to fall. Traders may look to sell or short sell.
If the price rises after a shooting star, the price range of the shooting star may still act as resistance. For example, the price may consolidate in the area of the shooting star. If the price ultimately continues to rise, the uptrend is still intact and traders should favor long positions over selling or shorting.
Example of How to Use the Shooting Star
In this example, the stock is rising in an overall uptrend. The uptrend accelerates just prior to the formation of a shooting star. The shooting star shows the price opened and went higher (upper shadow) then closed near the open. The following day closed lower, helping to confirm a potential price move lower. The high of the shooting star was not exceeded and the price moved within a downtrend for the next month. If trading this pattern, the trader could sell any long positions they were in once the confirmation candle was in place.
The Difference Between the Shooting Star and the Inverted Hammer
The inverted hammer and the shooting star look exactly the same. They both have long upper shadows and small real bodies near the low of the candle, with little or no lower shadow. The difference is context. A shooting star occurs after a price advance and marks a potential turning point lower. An inverted hammer occurs after a price decline and marks a potential turning point higher.
Limitations of the Shooting Star
One candle isn’t all that significant in a major uptrend. Prices are always gyrating, so the sellers taking control for part of one period—like in a shooting star—may not end up being significant at all.
This is why confirmation is required. Selling must occur after the shooting star, although even with confirmation there is no guarantee the price will continue to fall, or how far. After a brief decline, the price could keep advancing in alignment with the longer-term uptrend.
Utilize stop losses when using candlesticks, so when they don’t work out your risk is controlled. Also, consider using candlesticks in conjunction with other forms of analysis. A candlestick pattern may take on more significance it occurs near a level that has been deemed important by other forms of technical analysis.
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