inverted hammer

Inverted Hammer Candlestick Pattern: Definition, Trading, Example, Strategy

The Inverted Hammer candlestick pattern is a bullish reversal that forms in a downward price swing. As the name implies, it has the appearance of an inverted hammer — a small body at the lower end and a long upper shadow. It shows that the buyers are gaining momentum against the sellers and might soon push the price higher. The pattern is widely used by traders to identify the beginning of a potential upswing so as to enter long positions.

Candlesticks are a popular charting technique used in the technical analysis of financial markets. The shape of the candlestick can provide insight into market sentiment and potential future price movements. One popular candlestick pattern that is commonly seen on price charts is the Inverted Hammer. What do you know about the Inverted Hammer candlestick pattern trading strategy?

In this post, we take a look at the Inverted Hammer candlestick pattern trading strategy.

Understanding the Inverted Hammer candlestick pattern

The Inverted Hammer candlestick pattern is a bullish reversal pattern that forms at the bottom of a downward price swing. As the name suggests, it resembles an inverted hammer, and it is characterized by a small real body located near the lower end of the candle, a little or no lower shadow, and a long upper shadow.

In an Inverted Hammer formation, the color of the real body is not as important as its position — it must form at the lower end of a downward price swing, otherwise, it could be called a shooting star if it forms at the top of an upward swing. A green or white real body is considered more bullish, while a red or black real body is considered less bullish. However, any Inverted Hammer pattern can still indicate a potential bullish reversal even if it has a red real body.

The pattern is formed when the price opens lower, rallies during the day, but closes near its opening price. The long upper shadow indicates that the bulls tried to push the price higher, but the bears fought back and brought the price down. But despite the late fightback by the bears, the bulls are gaining confidence.

The Inverted Hammer is a significant pattern because it shows that the bears are starting to lose control, and the bulls are gaining momentum. This can indicate that a reversal to an upswing is possible. However, it is important to note that this pattern is a single-candle formation and should be confirmed by other technical analysis tools and indicators.

Traders often use the Inverted Hammer pattern in combination with other signals, such as a trendline, a support level, moving averages, and momentum oscillators, to confirm a reversal and make trading decisions.

Inverted Hammer Candlestick Pattern Backtest

We recommend backtesting absolutely all your trading ideas – including candlestick patterns.

In order to backtest candlestick patterns you need to set specific rules and definitions. That requires both time and effort, but don’t worry: it’s already done for you!

We have defined ALL 75 candlestick patterns and put them into strict trading rules that are testable. Each single candlestick pattern is backtested and includes rules, settings, statistics, probabilities, and performance metrics.

Even better, you get the rules with Amibroker or Tradestation/Easy Language code (in addition to plain English if you like to code yourself, like putting it into a Python trading strategy, for example).

Click here to read more or order.

How to identify an Inverted Hammer pattern in trading?

The Inverted Hammer candlestick pattern is identified by a small body located at the bottom, a little or no lower shadow, and a long upper shadow, resembling an upside-down hammer.

It’s a formation on the price chart that signals a potential upward reversal in a downward price swing. It is characterized by a small body located at the bottom, a little or no lower shadow, and a long upper shadow, resembling an upside-down hammer. This is how you can identify the Inverted Hammer pattern:

  1. Look for a downswing: The first step in identifying the Inverted Hammer pattern is to look for a downward price swing, which can be an impulse wave in a downtrend or a pullback (retracement) in an uptrend. The Inverted Hammer pattern has to form at the lower end of the downswing. If it forms at the top of an upswing, it will be called a shooting star pattern.
  2. Look for a single-candle pattern: The Inverted Hammer pattern is a single-candle formation, so look for a single candle in the chart that fits the pattern’s characteristics.
  3. Check the body: The body of the candle in the Inverted Hammer pattern is typically small and can be either bullish or bearish in color. It must be near the lower end of the pattern. So, look for a small body at the lower end, with a bearish or bullish color.
  4. Check the upper shadow: The most distinctive feature of the Inverted Hammer pattern is its long upper shadow, which is at least twice the length of the body. Look for a long upper shadow that is at least twice the length of the body.
  5. Check the lower shadow: The lower shadow of the candle is typically short or non-existent.
How to identify an Inverted Hammer pattern
Inverted Hammer pattern example
Inverted Hammer candlestick pattern backtest

The meaning of an Inverted Hammer pattern

The Inverted hammer pattern suggests that buyers are starting to assert control over sellers and prices may soon rise. The pattern is formed around the lower end of a downward price swing, which can be an impulse wave in a downtrend or a pullback in an uptrend. Traders frequently use this pattern as a cue to enter into long positions, as it signals the start of a potential upward price swing, especially after a pullback in an uptrend.

One of the main features of the Inverted Hammer pattern is that it often forms around important support levels, so it can indicate a potential bullish price reversal. This can help traders make more informed trading decisions, particularly those who are looking to confirm their bullish outlook in a down market or trying to know the end of a pullback in an up-trending market.

Another interesting thing about the Inverted Hammer is that it forms when the market seems oversold, and mean-reversion traders are looking to enter long positions. So, it helps these traders confirm their bullish bias in the market. The Inverted Hammer pattern can also provide traders with insight into market sentiment and the balance of power between buyers and sellers.

However, while the Inverted Hammer pattern can be a useful tool for traders, it may be pretty useless by itself. It must form in the right context to have any significance, which is why it must be used with tools like trendlines, support levels, moving averages, and momentum oscillators.

Benefits of using an Inverted Hammer pattern in trading

Let’s look at the benefits of using the Inverted Hammer pattern. The Inverted Hammer candlestick pattern is not only popular among price action traders and technical analysts, but also, occurs fairly frequently on the price chart of different assets and instruments. Using an Inverted Hammer pattern in trading can offer several benefits for traders looking to profit from potential bullish swings in the market. Some of the benefits of using this pattern include:

  • It occurs very commonly on price charts: The Inverted Hammer is a very common candlestick pattern. It occurs very frequently and can be seen on any chart.
  • It is easy to spot: The pattern is a simple single-candle formation that is easy for traders to spot and identify, making it accessible for both novice and experienced traders.
  • It can be relatively reliable: The pattern is considered a fairly reliable bullish reversal signal, making it a useful tool for traders looking to profit from potential bullish swings.
  • It can be confirmed with other trading tools and indicators: One can use technical indicators, such as trendlines and support levels, to support the bullish bias and increase the reliability of the pattern.
  • It is flexible to use: The Inverted Hammer trading strategy can be used in various market conditions and timeframes. It can be combined with other technical analysis tools to create a comprehensive trading plan.
  • It shows a clear stop-loss level: Traders can use stop-loss orders and other risk management techniques to limit their potential losses, making it a safer trading strategy.

How to trade using the Inverted Hammer candlestick pattern

There are several ways to trade the Inverted Hammer pattern. The Inverted Hammer pattern is considered a bullish reversal pattern, especially if it forms at the bottom of a downward price swing (which can be a pullback in an uptrend or a downswing of a downtrend). So, it can be used to identify buying opportunities in the market, especially for swing trading.

But the pattern should not be used as a lone signal. You should make it a part of a robust trading strategy where the pattern can help show bearish reversal signals. For a simple price action swing strategy that uses a trendline, support levels, and the Inverted Hammer pattern, here are the steps to trade it:

  • Use a trendline to delineate the direction of the trend and make sure there is an uptrend
  • Mark the support levels below the price with a horizontal line
  • Wait for the price to retrace to a support level or the trendline
  • Look for the Inverted Hammer pattern around the support level
  • After confirming the Inverted Hammer pattern around a support level, place a buy order at the opening price of the next candle
  • To manage risk, set a stop loss order below the swing low where the Inverted Hammer pattern formed
  • Set a profit target just below the next support level
  • Monitor your trade and adjust as you deem fit

You can automate this process with trading algorithms if you know how to code, or you can hire a programmer to do it.

Key considerations for trading with the Inverted Hammer pattern

The key considerations when trading the Inverted Hammer, is to be mindful of several key considerations to help maximize profits and minimize risks. One of the key considerations is market context. It is essential to understand the overall market context. This includes being aware of the market trend and any major economic or political events that may be affecting the market. But more specifically, it implies studying the market structure and trend — it is better to trade the pattern in an uptrend, where it can signal the end of a pullback and the beginning of a new bullish impulse swing.

In addition, to ensure the validity of the bullish reversal signal given by the Inverted Hammer, traders should also look for confirmation from other technical indicators, such as trendlines, moving averages, momentum indicators, and volume analysis. The trading volume can provide insight into the strength of a trend and the potential for a trend reversal.

To minimize potential losses, traders should utilize stop-loss orders and implement proper risk management through position sizing and diversification. It’s important to set a stop-loss to limit potential losses and protect capital in case the price moves in the opposite direction. Additionally, spreading out risks through diversification across different markets and timeframes is also worth considering.

Profitable trading strategies using the Inverted Hammer pattern

The Inverted Hammer candlestick pattern is a bullish reversal pattern that forms in a downward price swing. It shows that the buyers are gaining momentum against the sellers and might soon push the price higher. The pattern is widely used by traders to identify the beginning of a potential upswing, especially in an established uptrend, providing opportunities to open long positions.

There are different strategies traders can use when trading the Inverted Hammer pattern. One of them is swing trading using a trend-following strategy. Since the pattern has a bullish reversal implication, price action swing traders may use it to ride impulse swings in an up-trending market. In this case, they wait for the price to retrace to a key support level and enter long positions if an Inverted Hammer pattern forms, signaling the end of the retracement and the beginning of the next impulse swing to the upside.

Another strategy that can use the Inverted Hammer pattern is mean reversion. In this strategy, the trader believes that the price would rise back to its mean after trading significantly below it. To implement this strategy, the trader may use a moving average indicator to know the mean and use the stochastic or any other momentum oscillator to identify when the market seems oversold. Other tools for the strategy are the support levels and, of course, the Inverted Hammer pattern.

If the Inverted Hammer pattern forms at a key support level when the stochastic is rising from an oversold level, a mean-reversion trader can enter a long position and ride the anticipated price upswing toward the moving average line.

Real-life examples of successful Inverted Hammer trades

The Inverted Hammer candlestick pattern is very common on price charts. Here are two example trades on the Meta Platforms, Inc. stock chart.

In the chart above, you can see the trade setups formed by the Inverted Hammer candlestick pattern when the price pulled back to the trendline or the 14-period moving average (both of which act as dynamic support levels).

Trade entry is at the open of the next candlestick. Notice where the stop loss should be — below the low of the pullback. The profit target can be at the next resistance level, or you can use a 2:1 reward/risk ratio — any of those methods can make you money.

Enhancing your trading performance with the Inverted Hammer pattern

The Inverted Hammer candlestick pattern is a powerful tool for traders seeking to increase their trading performance in the financial markets. To use this pattern to improve your trading results, you need to understand its characteristics and how to use it to identify high-probability trade setups.

Being a bullish pattern, the Inverted Hammer is best used in an up-trending market. This way, you can have two factors that support the trade: the trend and the Inverted Hammer pattern. Adding a key support level to the equation also increases the odds of success. Another confluence factor could be to use a momentum oscillator like the stochastic to confirm there is an oversold condition in the market when the pattern formed. So, your best probability trade setup is to have the following aligned:

  1. An up-trendline or a 200-day moving average showing an uptrend
  2. A pullback to support level
  3. The stochastic rising from an oversold level
  4. An Inverted Hammer pattern at the support level

In addition to getting a good entry point with the four confluence factors above, you need to have proper risk management strategies, including position sizing and the use of stop loss. Risk only 1-2% of your capital on a trade and set your stop loss below the low of the downward price swing where the Inverted Hammer formed. Set your profit target just below the next resistance level or use a 2:1 reward/risk ratio.

You can also diversify your portfolio across different markets and different timeframes to spread out your risk and enhance your trading performance. Trading different markets and timeframes manually at the same time is near impossible, so you would have to automate your strategy with the help of trading algorithms.

Common mistakes to avoid when trading with the Inverted Hammer pattern

Here are some of the most common mistakes to avoid when trading with the Inverted Hammer pattern. In trading, it is important to be aware of mistakes that can affect your success and profitability.

  • Not considering the market context: Although the Inverted Hammer pattern is a bullish reversal pattern, it is ineffective when traded in the wrong market situation. It is important to consider the overall market context before making a trade to avoid unnecessary losses.
  • Not seeking confirmation: The Inverted Hammer pattern is a powerful signal, but you should always seek confirmation from other technical indicators before making a trade. Moving averages, momentum indicators, and volume analysis can all provide valuable information. Without confirmation, you will get many false signals.
  • Ignoring trading volume: Trading volume is an important factor to consider when trading with the Inverted Hammer pattern, as a high trading volume may support the bullishness of the pattern. Not considering the trading volume opens you to many false signals.
  • Neglecting risk management: Risk management is an important aspect of any trading strategy, so you should always consider it when trading with the Inverted Hammer pattern. Neglecting that could lead to huge losses.
  • Not having a defined trading strategy: You must have a comprehensive trading strategy when trading with the Inverted Hammer pattern, or else, you will make unnecessary trading errors, including emotional trading.
  • Not backtesting your strategy: Backtesting helps you to know how your strategy would have performed in the past. Without this clue, you may be throwing money away with an unprofitable strategy.
  • Overtrading: Overtrading is a common mistake that many traders make because the Inverted Hammer pattern occurs frequently. This can lead to many trading errors.

What does the Inverted Hammer candlestick pattern indicate?

The Inverted Hammer is regarded as a bearish candlestick pattern, but it depends on the circumstances: does the pattern occur when the asset is overbought or oversold?

Our backtests indicate, indeed, that the pattern is bearish when it happens in an overbought condition, meaning the market has risen recently and is perhaps running out of steam.

Conversely, if it happens during a downturn in the market, it tends to be more bullish. However, there much better candlestick patterns that can be labeled bullish, so we regard the Inverted Hammer as a bearish pattern.

How often does the Inverted Hammer Candlestick pattern happen?

The Inverted Hammer is the 11th most frequent candlestick pattern (in terms of frequency among the 75 candlestick patterns that exist). For S&P 500 we have had 132 Inverted Hammers since 1993 until today. Thus, we the chart pattern happens pretty frequent comparatively.

We have backtested and quantified all candlestick patterns. QuantifiedStrategies is all about statistics and facts, not bias and anecdotal evidence!

How reliable is an Inverted Hammer in technical analysis?

Overall, the Inverted Hammer is a reliable candlestick pattern.

But it also depends on the market you are trading. Some traders believe it is very reliable, while others disagree and argue it is not.

Luckily, to settle the debate, and unlike much of the nonsense floating on the web, we have quantified the candlestick pattern into specific trading rules so we can backtest it to find out how reliable the inverted hammer is in technical analysis.

If we backtest the ETF that tracks S&P 500, which has the ticker code SPY, we get 132 trades with the inverted hammer. If we exit after 1-10 trading days we get a win ratio from 53 to 65%. We would argue that this indicates a pretty reliable pattern.

We recommend you have a look at our quantified candlestick research.

The reliability of the inverted hammer candlestick pattern can be further improved by looking at the RSI levels, for example. This is an example of the research we cover daily on our Daily Trading Edge.

How accurate is the Inverted Hammer candlestick pattern?

The Inverted Hammer candlestick pattern has a win rate of 70% in our backtests, meaning it’s pretty accurate and good at getting winners. However, it’s only ranked 39th among the 75 candlestick patterns. Thus, there are more accurate candlestick patterns.

When does an Inverted Candlestick pattern occur?

The Inverted Candlestick happens most frequent when the market is overbought. 58% of the Inverted Hammers happen when the market is overbought compared to only 42% when the market is oversold. We used the RSI indicator to measure overbought and oversold conditions.

Is an Inverted Hammer Candlestick pattern profitable?

Yes, the Inverted Hammer candlestick pattern is profitable because it has resulted in an average gain of 0.36% per trade for S&P 500, according to our backtests. If you use it with other tools, for example, the RSI indicator, the gains are even higher.

As mentioned further up in the article, we have quantified and backtested the inverted hammer pattern on S&P 500 and we got the following equity curve:

Is an Inverted Hammer Candlestick pattern profitable
Is an Inverted Hammer Candlestick pattern profitable

But as with all trading, you need to know how to trade and be systematic. The pattern, of course, also depend on a lot of factors you have no control over, such as market volatility and geopolitical risks.

Is the Inverted Candlestick pattern a buy or sell?

The Inverted Candlestick pattern is mostly a buy. For S&P 500 it has resulted in an average gain of 0.36% per trade, according to our backtests.

How to trade the Inverted Candlestick pattern in the stock market?

Trading with Inverted Hammer Candlestick pattern in the stock market involves a logical and quantified approach. If you don’t use numbers and backtesting, how do you know if you have a positive expectency? This is why we recommend backtesting so you don’t trade blindly. It’s far too easy to be fooled by anecdotal evidence. If you use numbers and backtesting, most trading strategies are not so obvious as it seems!

We recommend this approach:

What are other types of Candlestick besides Inverted Hammer?

Let’s look at the different candlestick patterns that might resemble the inverted hammer (the most obvious ones):

  • Shooting star: Also known as the bearish pin bar among western traders using the bar chart, the formation is seen after an asset’s market price is pushed up quite significantly but then gets rejected at higher prices, which indicates that the price may be about to decline.
  • Morning Star: This pattern is composed of three candlesticks, with the first one being a tall bearish candle. The second candle is a small one that opens and closes below the first candle, creating a gap. The third candle is bullish and closes above the midpoint of the first candle.
  • Evening Star: The pattern consists of three candles that make up the pattern — a tall bullish candle followed by a small candle that gaps above the first candle, and then a third candle that is bearish and closes below the midpoint of the first candle.
  • Engulfing pattern: This is a two-bar pattern where the second “engulfs” the pattern the day before.
  • Doji: The “body” is very small and the “shadows” are long.
  • Spinning top: A spinning top has a small body that closes in the middle of the candle’s range, with long wicks on both sides. We have covered a bearish spinning top.

Is a Shooting Star the Same as An Inverted Hammer?

The Inverted Hammer is not the same as Shooting Star, but they are within the ballpark the same. However, they are not identical.

Shooting Star

Also known as the bearish pin bar among Western traders using the bar chart, the formation is seen after an asset’s market price is pushed up quite significantly but then gets rejected at higher prices, which indicates that the price may be about to decline.

Inverted Hammer

The Inverted Hammer has a small body at the lower end and a long upper shadow. It shows that the buyers are gaining momentum against the sellers and might soon push the price higher. It is most powerful after a decline, but it also depends on which market you are trading.

What are the disadvantages of an Inverted Hammer Candlestick?

The main disadvantage of the Inverted Hammer candlestick pattern is that it’s subjective, might lack clarity, has false signals, and is not suitable for every time frame. Let’s look at the disadvantages and cons in detail:

  • Subjectivity and interpretation: Most candlestick traders use VERY subjective interpretations of the pattern. Needless to say, this makes it difficult to track your performance. What is an inverted hammer and what is a doji, for example? This is why we recommend using quantitative analysis which rules out all subjective feelings.
  • Lack of clarity: Also, when do you sell? Getting into a trade is just half the job. Even the best candlestick patterns need a clearly defined trading rule for when to sell.
  • False signals: As indicated in another heading further up in the article, the inverted hammer is quite reliable. But that doesn’t mean it has no false signals. Part of trading is to accept losses, and the inverted hammer has false signals. That is part of the game, and every technical analysis tool is the same. This is why you need additional tools to use together with the inverted hammer.
  • Limited timeframe suitability: Choosing the right time frame is important. What is the best time frame for candlesticks? The Inverted Hammer is best used on daily bars, not weekly or monthly. We believe it’s not very suitable for day trading either.

What are the advantages of an Inverted Hammer candlestick?

The main advantage of the Inverted Hammer is that it provides value if you are looking for bullish reversals. Let’s look at some other advantages:

  • Reversal indicator: After a decline, the Inverted Hammer pattern works as a reversal indicator or pattern. It’s a good market bottom signal for a short-term trade.
  • Confirmation with other indicators: If combined with other indicators, it has a good track record in indicating reversals. For example, the RSI indicator is a good trading tool for spotting oversold levels. Combined with the Inverted Hammer, you have a potentially potent strategy.
  • Entry and exit points: It is good at pinpointing entry and exit points and levels.
  • Applicable to many time frames: The Inverted Hammer works best on daily bars, but can also be of significance on weekly bars.
  • Simple recognition: The Inverted Hammer is pretty easy to recognize on a chart, and it is also pretty easy to convert it into specific quantified trading rules. It stands out due to its distinctively lengthy upper shadow, short body, and minimal to no lower shadow, which helps traders spot probable bullish reversal opportunities.


FAQ:

When does the Inverted Hammer pattern form?

The Inverted Hammer candlestick pattern is a bullish reversal formation that occurs in a downward price swing. It is characterized by a small body at the lower end and a long upper shadow, resembling an upside-down hammer. The Inverted Hammer pattern forms at the bottom of a downward price swing, indicating a potential end to the downward movement.

How can traders identify an Inverted Hammer pattern on a chart?

The Inverted Hammer pattern signals a potential reversal as it shows that buyers are gaining momentum against sellers, suggesting a possible upward price movement. Traders can identify the Inverted Hammer pattern by looking for a single candle with a small body near the lower end, a long upper shadow (at least twice the length of the body), and a short or non-existent lower shadow.

How can traders use the Inverted Hammer pattern in their trading strategy?

Traders can use the Inverted Hammer pattern for swing trading in an up-trending market. It can also be incorporated into mean reversion strategies by identifying oversold conditions. Risks of using this pattern include not considering the market context, neglecting confirmation from other indicators.

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