How to profit with hammers - Check these 3 boxes to make it work
The 'hammer' is a candlestick chart pattern indicating reversal.
What Is a Hammer Candlestick?
The 'hammer' is a candlestick chart pattern indicating reversal. Investopedia offers this definition:
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.
After yesterday's market action there are potential hammer candlestick patterns everywhere. These patterns can be great trading signals when used correctly.
To use hammers effectively in your trading to need to make sure these three conditions are met.
The hammer comes after a down move
Whether your using a 5 minute chart, a daily chart, or longer there must be declining price action over the previous periods, preferably 5 or more.
The hammer is confirmed.
A hammer is most useful after it is confirmed. Confirmation comes when price action in the following period increases and moves higher than the top of the hammer.
Extension from the short term moving averages
An ideal hammer setup will have some distance between it and the shorter term moving averages. I use the 8 and 21 period exponential moving averages. Some like to use a 5 and 20 period EMAs. Whatever you use you don't want to see the hammer close, or in between these averages.
Once these three boxes have been checked you can look at crafting your game plan for a trade here. Keep in mind, by design and definition a hammer candle is a potential reversal pattern. That means the trade will be counter trend, at least on a shorter timeframe. So as always, remember to proper utilize your rules around risk management: position sizing, covering risk, proper stops, trailing stops, and targets.
Apple $AAPL showing a potential hammer pattern on the daily chart