Inverted Hammer Candlestick Pattern: Candlestick patterns are a part of technical analysis preferred by traders to understand and predict the future price movement in securities.

In this article, we shall discuss the Inverted hammer candlestick pattern and its meaning and types, as well as how to set up a trade with the pattern formation.

Inverted Hammer candlestick pattern – Definition

The Inverted Hammer candlestick pattern is a bullish reversal pattern that occurs at the end of a downtrend, indicating a potential change in market direction from bearish to bullish. 

It is characterized by a small body (can be red or green) and a long upper shadow, also known as the “tail.” The pattern suggests that buyers are gaining strength and pushing the price up despite the selling pressure in the security. The long upper shadow represents the buyer’s initial attempts to push the price higher, suggesting a possible bullish reversal.

Inverted Hammer Candlestick Pattern – Psychology

The psychology behind the Inverted Hammer pattern suggests the initial attempt of the buyers to take control of the security. When the security is in a bearish trend, there is a sudden entrance of the buyers which pushes the price of the security higher.

However, the sellers managed to push the price down by the end of the trading session which caused the long upper wick of the pattern. Although the price was lower by the sellers by the end of the session, the long implies the emergence of buyers ready to push the price higher.

The appearance Inverted Hammer pattern is best suited near a previous support level as those are the levels where a strong demand for security exists.

As the buyers have completely not overthrown the sellers, this pattern requires confirmation from the next candles, which should be bullish and close above the high of the Inverted Hammer, to confirm the bullish reversal.

Inverted hammer candlestick pattern – Trading Ideas

Spotting the formation of an inverted hammer pattern defines the trade opportunity of a good risk-to-reward ratio. The pattern formation at the bottom of a downtrend signals a reversal towards the upside in security. Following are the steps to trade an Inverted hammer pattern.

Entry:- It is always preferred to place a long position after the price closes above the high price of the inverted hammer pattern.

Stop loss:- As a part of risk management, trading with stop loss and respecting the logical stop loss is important. Thus, one should place a stop loss to the long position can be placed at the lowest price of the inverted hammer pattern formed in security.

Profit Target:- For the long position entered in an inverted hammer pattern, the profit target can be based on the risk-to-reward ratio. Also, the profit targets can be set to the next resistance levels from the entry of the position.

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Inverted Hammer Candlestick Pattern – Example

In the above chart of Axis Bank, we can observe the formation of an Inverted Hammer candlestick pattern. As discussed in this article, the price saw a Reversal in trend after the formation of the pattern.

At the time of the formation of this pattern, a trader could have taken a long position when the price of the stock started trading above Rs. 534.15 and the stop loss was at Rs. 515.

Aspects to confirm the pattern

Here are a few criteria to consider for the confirmation of inverted hammer candlesticks.

• The trader should confirm that the shadow of a pattern formed should be at least two times larger than the body of the pattern.
• The entry should be confirmed by the next candle with its closing price higher than the pattern formed.
• The prior trend should be a downtrend.
• The colour of the candle doesn’t have any impact on pattern formation.

Conclusion

Analysing the price movement of securities with candlestick patterns helps traders to identify better entry opportunities. From the above learnings, employing an inverted hammer candlestick pattern helps to build views in security to trade with better risk management and reward ratios to make profits.

The Inverted Hammer pattern is a powerful reversal signal that can be used in conjunction with other technical indicators to confirm a trend reversal. It is an important pattern to recognize in technical analysis as it can help traders identify potential changes in market direction and make informed trading decisions.

Written by Deepak

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