The hammer candlestick when used properly may just be the best candlestick pattern in forex trading.
Forex Hammer Candlestick
SIGNAL: Bullish, Strong
This candlestick pattern consists of three individual forex candles. Unless otherwise stated, each individual candle can be either bullish or bearish. The three candles are:
- Setup Candle: The first candle is bearish and preferably occurs at the end of a significant push down in price.
- Signal Candle: The second candle is the classic hammer Rejection Candle: a comparatively short body with a comparatively long tail. Preferably occurs at a strong Support level.
- Confirmation Candle: the third candle is a strong push upwards in price represented by a comparatively long bullish body.
PSYCHOLOGY AND FUNDAMENTALS
This candlestick pattern sets up at the bottom of a move down in price. The two scenarios are:
- It can occur at the end of a long run down which exhausts the supply of sellers and draws buyers into the market at the drastically reduced prices. At this stage buyers will be more inclined to enter the market on the offer of a currency pair at comparatively cheap levels. At the same time, sellers are beginning to exit the market as they take profit on the realisation that the surge downwards cannot last forever. Thus price rises.
- The hammer pattern can also occur in an uptrend when price temporarily retraces, preferably to a support level. This temporary move downwards may be due to buyers taking profit, sellers moving into the market at the relatively elevated prices, or just normal cyclical market exhaustion as the buy orders thin out. Hence price moves down to a level of support where buyers are ready to once more start moving into the market, pushing price up again.
TRADE ENTRY & STOP LOSS
You can enter either a Buy Stop order 2 to 5 pips in front of the highest price the confirmation candle reached, or if you are confident enough of the move upwards you can enter aggressively with an At Market order. Either way, your Stop should go 2 to 5 pips below the wick of the signal candle. This is a rough guide only: in volatile markets you may choose to extend the stop further out, and for much higher time frame charts such as the daily you may set stops 5 to 20 or even more pips behind the wick of the signal candle.
The larger the bullish candle that confirms the pattern, the more likely price will move upwards. However, if the confirmation candle is extremely long you may have trouble getting in with a reasonable reward to risk ratio.
For example, you may have to set a stop loss of 50 pips if the confirmation candle plus the signal candle combined represent around 50 pips. If there is a strong area of resistance only 20 pips above current price action, you may consider this to be a low probability trade and pass on the opportunity.
Forex Candlesticks are the MARKET PULSE, defining current Price Action and the Market Sentiment that is driving price action. My candlesticks course covers the seven things you absolutely must know about this most basic building block of price action. It includes the AuthenticFX Forex Candlestick Glossary, the perfect tool for you to master candlestick patterns with: