Trading the Bullish Hammer Candle.
by Walker England, Trading Instructor.
Interpreting Japanese candlesticks can give a trader important insight into market momentum. By understanding how to read candles, traders can often include them in their analysis to find areas of price continuations and possible reversals. Today we will focus on one candle that can help validate a charts reversal point. Let’s learn to identify and trade the bullish hammer candle.
What is a bullish hammer?
A bullish hammer differs from other candle patterns as it is a single candle hinting at a turn during an established downtrend . Pictured above the hammer is interpreted by understanding a candles particular open, low high and close levels . To create a hammer price must first significantly sell off to create a new low for a currency pair. However, after this decline, prices must significantly rally causing prices to have a small body and close near its opening price. It should be noted that hammers should have long wicks at least twice the length of the candle body. As well, the candle itself can either be red or blue depending on the strength of the reversal.
Often the bullish hammer is confused with a bearish hanging man candle. The misrepresentation is logical because both candles look identical! The difference between these two candles lies in their placement in a trending market. The hanging man has a small body and lock wick but is found hanging at the conclusion of an uptrend. Bullish hammers have small bodies and long wicks also, but are only seen at the end of a downtrend.
Uses in Trading.
Bullish hammer candles can be found on a variety of charts and time frames. Depicted above is an example of the hammer on the AUDUSD daily chart. From February the 29 th through June 1st the AUDUSD rallied as much as 1276 pips. This downtrend was concluded with a bullish hammer candle, and price has subsequently rallied a total of 1033 through today’s price action.
As the strength of a hammer depends on its placement on the graph, normally traders use this candle in conjuncture with other indications of price support. This includes using tools such as fib lines, pivot points and psychological whole numbers . In an ideal scenario, the wick of the hammer will penetrate a support level but the body will close above support on renewed buying sentiment. With a new buying opportunity presented, traders may then choose to place stops under the created wick below support.
---Written by Walker England, Trading Instructor.
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The Hammer Trigger for Bullish Reversals.
Price action and Macro.
Traders can utilize Price Action in an attempt to find short-term reversals in markets In this article, we touch on five of the most common Bullish Reversal patterns Multiple Time Frame Analysis can be used to trade reversals in direction of longer-term trend.
In our last Price Action article, we looked at trading Bearish Reversals in the Forex Market. In this article, we’re going to go over some of their bullish-counterparts, with specific focus on the hammer formation.
But rather than just show some candlestick setups, we’re going to try to take this a step further, as we have with all of our Price Action articles , in explaining the rationale for ‘why’ these setups are important for traders to recognize.
If you would like a guide for how reversals should be treated, please don’t hesitate to check out any of our previously published resources on the topic. Trading Bearish Reversals supplies a model that traders can utilize in reverse to trade in bullish scenarios; and the article ‘Trading Reversals’ will provide a much more high-level view on the topic of reversals in general.
The Hammer formation is probably one of the more telling bullish reversal formations that traders can find in markets, and it’s also one of the formations that will most ‘stand out’ to traders.
The Hammer has a long wick on the bottom of a Bullish candlestick.
Created with Marketscope/Trading Station II.
The hammer formation tells the trader quite a bit. During this candle’s formation, prices ran down quickly, only to reverse. And not only did prices reverse, but they reversed beyond their initial opening price, thereby creating a bullish candle.
This setup can be especially attractive if the long wick on the bottom of the candle is sitting outside of previous price action. In the picture below, we look at the same hammer formation that we looked at in the above graphic; but this time we’re going to look at the formation with some context:
A Bullish Hammer to trigger in direction of previously established trend.
Created with Marketscope/Trading Station II.
Notice in the above picture on the British Pound against the US Dollar, a nice and strong up-trend had formed before running into a retracement (in red).
During the retracement, a hammer formation forms (the same candle we looked at in each of the previous two illustrations).
Traders can look at this an entry opportunity, looking for the previously established trend to continue in that direction.
Traders can look to enter once the hammer formation has completed (the candle has closed), with a stop just below the low of the hammer’s wick.
If the previously established trend comes back, the trader can look for 2, 3 or even 4 times the amount they are risking at the outset of the trade.
The inverted hammer is another bullish candlestick formation that will often be found at or near the bottom of a retracement in an up-trend.
The inverted hammer is opposite of the hammer formation, in the fact that the bullish body of the inverted hammer is at the bottom of the formation, with a long wick sitting atop the body. The picture below will illustrate further:
The Hammer formation shortly before an up-trend sets in the market.
Created with Marketscope/Trading Station II.
The inverted hammer is often found at the bottom of a move, and will indicate a potential reversal in the near-term trend. The logic of this candle is similar to the logic of the hammer. During this candle’s formation, prices ran high, but sellers came in to bring prices lower before the candle completed.
Inverted Hammers v/s Shooting Stars.
Many traders will often confuse the inverted hammer formation with the ‘shooting star’ formation that we looked at in our last article, Trading Bearish Reversals .
The Shooting Star formation as shown in Trading Bearish Reversals.
Created with Marketscope/Trading Station II.
There are some key differences to note between these two formations. Firstly, the shooting star is bearish, while the inverted hammer is bullish; and as such, the shooting star candlestick should be bearish, and the inverted hammer should be bullish.
But perhaps more importantly is the context of the market at the time of formation.
Shooting stars take place at the top of a move. And just like we looked at in Trading Bearish Reversals, trading shooting star formations is optimal in longer-term down-trends, with a near-term retracement (up-trend). This way the trader can look to the shooting star formation to initiate a short position for a reversal in the near-term up-trend, and a continuation in the longer-term down-trend.
The inverted hammer works similarly.
As a reversal formation, the inverted hammer should be found at the bottom of a move. But, once again, this can be a near-term down-trend or retracement, found within the longer-term up-trend. The trader can use the inverted hammer to trigger into the position, looking for the longer-term trend to continue, while playing the reversal of the near-term retracement.
If you would like more information on this style of trading, our article covering multiple time frame analysis can assist in helping traders separate longer-term trends, from near-term movements.
-- Written by James Stanley.
James is available on Twitter JStanleyFX.
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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
Upcoming Events.
Forex Economic Calendar.
Past performance is no indication of future results.
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Hammer.
What is a 'Hammer'
A hammer is a price pattern in candlestick charting that occurs when a security trades significantly lower than its opening, but rallies later in the day to close either above or near its opening price. This pattern forms a hammer-shaped candlestick, in which the body is at least half the size of the tail or wick.
BREAKING DOWN 'Hammer'
A hammer occurs after a security has been declining, possibly suggesting the market is attempting to determine a bottom. The signal does not mean bullish investors have taken full control of a security, but simply indicates that the bulls are strengthening.
Psychology of Hammers.
Hammers signal a capitulation by sellers to form a bottom accompanied by a price rise, to indicate a potential reversal in price direction. Hammers are most effective when they are preceded by at least three or more consecutive declining candles. Declining candles are indicated with lower low tails. This means prices reach a lower price than the low of the prior candle period. This illustrates the continuation of fear and selling pressure by participants feeling the pain of declining prices. Eventually, the pain becomes too great and forces the remaining sellers to panic out of their positions in a final selling frenzy, indicated by the lowest price being reached, followed by a quick rebound from the lowest price to close the candlestick with a small body. The tail should be at least twice the size of the candlestick body. It should look similar to a capital 'T'. This indicates the potential for a hammer candle. Note the term "potential."
Hammer Confirmation.
The true confirmation of the hammer candle can only be made when the very next proceeding candle closes with a higher low than the hammer candle. This confirms the capitulation from sellers, as buyers have determined the price is too attractive to pass up and quickly buy into the position. When the proceeding candles continue to consecutively form higher lows, it indicates that the buyers are now supporting the pullbacks buy and bidding up shares. As the price rises higher, it can also cause earlier sellers to reconsider and buy back into the stock or other financial instrument. One thing to remember is that the buyers may not actually be bullish on the stock.
In fact, early buyers can often be composed of short-sellers who must actually buy shares in order to cover their short positions and lock in profits when a hammer candle forms. As the price continues to recover, it can also cause late short-sellers to re-evaluate their short positions as earlier profits turn into losses. Hammers can be measured on any times frame candlestick chart. The larger the time frame chart, the more thorough the hammer candlestick will be, due to the more participants involved.
Trading the Hammer Candlestick – Price Action Strategies.
This article describes a short term, day trading strategy for trading hammers and hammer reversal signals.
Using Price Action Signals.
Indicators such as moving averages, oscillators and so on are good at characterizing broad market behavior. But they do have a major drawback.
They work mostly by “aggregating” price data over a certain period. This is done to remove noise and false signals.
This tradeoff between noise/delay is acceptable for the longer term position trader who is trying to capture wider market trends. But for the day trader who dips in and out of the market for a period of hours or less these kinds of signals have limited use. For day trading and scalpers a difference of a few pips on trade entry can make the difference between a winning and losing strategy.
What is price action ? “ Price action trading ” simply means analyzing raw price movements instead of looking through the lens of lagging indicators.
What are Hammer Candlesticks and Where Do They Form?
Hammer candles and their close cousins “hanging men” and dojis are one of the most fundamental patterns seen in financial charts. Easily identified, these are usually observed at turning points in the market. These patterns can be thought of as points where a reversal of sentiment is occurring.
Because of their properties hammers are a useful trading signal in two situations:
Trend reversals: Entering at the beginning of a changing trend (a trend turning point) Retrace scalping: Entering on the minor retracements that appear within an opposing trend.
Figures 2 and 3 below show some classic hammer patterns. In these I’ve used a Metatrader hammer indicator to identify the hammer patterns and display them on the chart. The green markers display bullish hammers. The red markers display inverted, or bearish hammer formations.
Figure 2 shows the characteristic appearance of hammers at market turning points. Each of these is a short duration swing within an active trend but as shown below they can mark profitable entries for scalp trades.
Figure 3 shows a close up view of a three-hammer formation marking the peak-trough of a single wave.
Figure 4 shows a formation occurring on a larger scale. This example shows a hammer appearing on the daily time frame as a major downtrend comes to an end. Notice also that the actual trend turning point (marked with a vertical line) is preceded by a fake hammer (#1).
Basic Hammer Strategy.
The strategy described here can be used as a scalper for both M1 and M5 timeframes. It works exclusively on the hammer signals.
Entry signals.
The trade entries are as follows:
Buy side signal – hammer formation: A buy order is placed on the bullish hammer signal. To filter weak signals, I look at the accumulator line over the past n bars (where n is an input setting). This is to confirm that a trend reversal is likely to take place. This helps to eliminate entry on false signals (see additional confirmations below).
A cut threshold is used so that the buy is only taken if the accumulator is below this absolute value.
Accumulator below threshold -> the market is overselling.
The indicator will identify both black and white hammers as bullish signals. However a white hammer is considered a stronger bullish signal. Entering on only “white hammers” reduces the number of trade entries by about one half. But in our back tests and live trading it didn’t improve the overall profitability of the strategy.
Sell side signal – bearish hammer formation: The sell side signal is basically the reverse of the above. A sell order is placed on the bearish reversal hammer or black hammer providing the lot limit isn’t reached (sell below).
Similarly the sell is only taken if the accumulator is above the cut threshold.
Accumulator above threshold -> the market is overbuying.
An explanation of the accumulator is given below.
In this strategy, I limited the exposure to one single lot placed in each order. I also prevented simultaneous long/short holdings. So if a buy signal appears when there is an open sell position, the buy is ignored. And vice versa, a sell signal is ignored where there is a current long holding. This means the strategy only holds a single position at a time.
Obviously, exposure (and risk) can be increased to any required amount by increasing the order volumes or trade multiples.
Confirmations.
Raw hammer signals tend to be very noisy and using them “blindly” is unlikely to result in a profitable strategy. This is why many “raw” hammer strategies fail over the long term in my view.
The hammer indicator already filters out weak and ambiguous signals. The aggressiveness of this filtering can be adjusted with input settings to the indicator. The remaining signals tend to be quite reliable. However, further confirmations can be used to check the conditions and to eliminate false positives as far as possible.
Accumulator line.
The accumulator is a type of oscillator. This signal can be used as an alternative measure of momentum similar to MACD, RSI or OSMA. The difference though is that it works purely on hammer signals. It can indicate an overbought/oversold market. The signal works as follows:
A bearish hammer increments the signal line by 1 A bullish hammer decrements the signal line by 1.
The signal rises when there are a series of bearish hammers which usually happens in an up trend. The signal falls when there are a series of bullish hammers which are usually seen in a down trend.
The theory behind this is that the market is reaching “overbought” when you have a series of bearish (reversal) hammers without a correction. These usually occur in an upward trend. The accumulator line will increase in this situation because each bearish hammer adds to the signal.
In a down trend the reverse happens. Each bullish hammer decreases the signal. So a series of bullish hammers without a correction will push the accumulator line downwards indicating that the market is reaching an oversold state.
This can be interpreted as follows:
High values indicate a dominance of bearish reversal hammers Low values indicate a dominance of bullish reversal hammers.
The greater the absolute value of the accumulator line, the more extreme the market position is considered to be. The direction and steepness of the slope is a measure of momentum.
When trading on hammer signals the accumulator can be useful. It gives an idea of trend strength and the likelihood that a hammer will actually result in a reversal or be a fake signal. Extreme values in the accumulator suggest that more of the hammer signals have been fake and have not preceded a reversal on the scale being examined. It also suggests that the market is reaching a “more unbalanced” position in being either overbought or oversold.
The accumulator can also filter out weak or ambiguous signals. For example, bullish hammers appearing when the overall trend is strongly bearish. Or when bearish hammers appear in a strong uptrend. In both cases, trading against the trend may be too risky without further confirming signals.
For examples see the figures above. Figure 5 shows the raw accumulator (summation of hammer signals). Figure 6 shows the smoothed line. Smoothing is used to filter and reduce noisy signals.
When trading price action, the accumulator signal is helpful to get a “perspective” on market direction and how it is changing beyond that given by an individual hammer signal. However the accumulator gives a different perspective because it works entirely on hammer formations and is independent of classic trend signal and oscillators.
Example 1: Dealing with fake hammers on breakout events.
As an example see Figure 7. The strong buy signal and the accumulator line suggest that the downtrend is capitulating. Shortly after, a clear upwards breakout happens. Following the break two “fake” bearish hammers appear as the market becomes “uncertain” of the next direction.
Notice that both of the sell hammers are much weaker than the initial buy signal. Meanwhile the rising accumulator line suggests that the trend is up and reversal hammers are appearing.
The fourth hammer is a strong sell signal. Entering short at this point (and the previous one) would actually result in a small profit.
The strategy would normally choose to avoid these “sell side” entries based on the fact that the signals are suggesting a strong upwards breakout is taking place. The fifth and final hammer indicates another buy signal, at which point the breakout enters a second wave of upwards momentum.
Example 2: Dealing with “border-line” cases in trends.
Bearish hammers are often seen in strong uptrends, and likewise, bullish hammers are seen in bearish downtrends. In some cases, these signals can actually result in highly profitable scalp trades. In other situations, the entries may simply be too risky to justify.
The following example demonstrates. In Figure 8, the overall trend is upwards, but within this trend, four bearish hammers appear.
The first and last indicate strong sell signals, and would actually result in an acceptable risk/profit ratio. The hammer strength confirms these as viable sell entries despite the upwards trend.
On the other hand, the middle two hammers (#2 and #3) are ambiguous. The hammer strength is weaker which suggests these may not be viable entry points. Given the current uptrend, these hammers would be filtered as below threshold. Finally, the fourth bearish hammer produces a strong sell signal and this does indeed precede a deeper retracement.
The accumulator line and the strength of the hammer are used to determining this and to separate between signals that are likely to mark the end of a trend or a just a swing.
Example 3: Dealing with hammer candle pairs and clusters.
Very often, hammers don’t appear in isolation. They appear in pairs, or sometimes even in large, messy clusters. One of the challenges of trading on price action signals is dealing with this kind of “noise”.
Using filtering we were able to reduce the frequency of double (and triple) hammers to around 1 in 20. In the cases where double hammers do appear these can be used as confirming signals. Often the first hammer to appear is the weaker of the two and is followed by a stronger signal in the next few bars (see Figure 9).
There are two ways to deal with double hammers:
1. Lot weighting method: If a strong hammer is detected (above threshold) this method looks back over a set bar range to see if a pair occurred. The bar range is usually set between 2 and 10 bars at the current chart period. If a previous hammer occurred, the second signal is used to increase the holding volume. With this method, the stronger signal is usually given a higher lot weighting. For example if the signal strength is double, then twice the lot weighting is used.
2. Clustering method: The clustering method assumes that “real” hammers will nearly always be preceded by one or two fake signals. An entry is made after the k th signal. For example, with k =2, the entry is only made after two confirming hammers appear in the same direction over the bar range. This method will result in far fewer trades, especially if strong filters are used to remove noisy signals.
For example, in Figure 10 below with k =2, the first signal would be ignored. But a buy would trigger at the first pair, and a sell at the second pair. In both cases the entry would trigger on the later hammer signal rather than the less profitable first.
Strategy Results.
I performed a number of back tests to help demonstrate the properties of the hammer signal. The tests were done with a ten year data set (EURUSD, GBPUSD, & USDJPY) and the following settings were used:
Base leverage: Set at one (1 standard lot per 100k equity) Maximum open positions: 1 standard lot.
The results are as follows:
The EURUSD run resulted in 595 trades a profit factor of 1.3, and a total profit of USD 85,849.50.
USDJPY run resulted in 600 trades a profit factor of 1.45, and a total profit of USD 127,088.20.
GBPUSD run resulted in 536 trades a profit factor of 1.32, and a total profit of USD 138,448.96.
As a comparison, the same test was run but using the unfiltered hammer signals: That is trading on every candidate hammer that appeared on the chart. This resulted in a loss of - USD 8,154.25. Similar results were achieved on the other pairs. This suggests that trading on “unfiltered hammer” signals is unlikely to produce a successful strategy over the long term.
Hammer candlesticks are an extremely useful price action (real time) trading signal. They are also easy to use and understand. Their real time properties make them ideal indicators for a variety of scalping and day trading strategies.
Hammer signals tend to be “noisy”. The main difficulty in implementing hammer strategies comes from separating these noisy and ambiguous signals from real ones. Systems that trade on raw hammer signals tend to perform poorly over the longer term (click to open graph of unfiltered result).
I presented several methods for dealing with these problems in this article. The hammer strategy was shown to produce profits under various market conditions of which trend followers and other systems based on lagging indicators can fail.
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I just purchase the full version of the hammer. What’s pairs and time frame do you recommend?
Should I keep trend 10 accumulator period 30 ?
It’s possible for feature you have a notification pop-up.
Thank you for your purchase.
It really depends on your trading goals. With the M5 timeframe shown here you tend to get a lot of trade entries so that’s why we used it for the demonstration. But actually hammer strategies can work on any pairs and any timeframes because these are very general signals. Personally I would start with EURUSD. The following settings are what we use for EURUSD with good results:
Confirm bars=100; shadow/body ratio=6.5; body position=0.1, accum=30.
Thanks for the suggestion about the popup: There is a sound alert that can be switched on.
Hello, I am a big fan of hammer candlesticks. I download your indicator Hammer detector but the Accumulator line it’s not working, it remains at 0.0000 this is how it’s suppose to be in the trial version ? or I am doing something wrong. Thank you.
Yes the demo version will display the hammers on the chart but it doesn’t create the numerical outputs. Which pairs are you trading?
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