The inverted hammer candlestick pattern: another great forex trend reversal and continuation pattern…
SIGNAL: Bullish, Strong
The inverted hammer 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 downwards in price.
Signal Candle: The second candle is an upside down or ‘inverted’ hammer candle occurring at the bottom of the move. It consists of a comparatively short body with a comparatively long tail.
Confirmation Candle: the third candle is a push up in price represented by a bullish body.
PSYCHOLOGY AND FUNDAMENTALS
Inverted hammers set up at the bottom of a move down in price, whether that move is part of a long-term trend or a short term retracement. 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 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. Buyers have already begun to enter the market at the signal candle, pushing price up to a level that will likely shake the confidence of bears. At this stage the sellers still appear to be in control, having managed to push price back down towards the lows. However, some 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 inverted 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 inflated 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 lowest price the confirmation candle reached, or if you are confident enough of the move down you can enter aggressively with an At Market order. Either way, your Stop should go 2 to 5 pips below the low 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 low of the signal candle.
The larger the bullish candle that confirms the pattern, the more likely price will move up. 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: