What is a Hammer Candlestick?

What is a Hammer Candlestick?

A hammer is a price pattern in candlestick charting that occurs when a security trades significantly lower than its opening, but rallies within the period to close near the opening price.

This pattern forms a hammer-shaped candlestick, in which the lower shadow is at least twice the size of the real body. The body of the candlestick represents the difference between the open and closing prices, while the shadow shows the high and low prices for the period.

Hammer candlesticks typically occur after a price decline. They have a small real body and a long lower shadow.

The hammer candlestick occurs when sellers enter the market during a price decline. By the time of market close, buyers absorb selling pressure and push the market price near the opening price.

The close can be above or below the opening price, although the close should be near the open in order for the real body of the candlestick to remain small.

Is a Hammer Candlestick Pattern Bullish?

The hammer candlestick is a bullish trading pattern that may indicate that a stock has reached its bottom, and is positioned for trend reversal. Specifically, it indicates that sellers entered the market, pushing the price down, but were later outnumbered by buyers who drove the asset price up.

Importantly, the upside price reversal must be confirmed, which means that the next candle must close above the hammer’s previous closing price.

Limitations of Using Hammer Candlesticks

There is no assurance the price will continue to move to the upside following the confirmation candle. A long-shadowed hammer and a strong confirmation candle may push the price quite high within two periods. This may not be an ideal spot to buy as the stop loss may be a great distance away from the entry point, exposing the trader to risk which doesn’t justify the potential reward.

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Hammers also don’t provide a price target, so figuring what the reward potential for a hammer trade is can be difficult. Exits need to be based on other types of candlesticks patterns or analysis.

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