Hammer Pattern

HAMMER

Description

The Hammer signal is aptly named. It looks like a hammer. The Hammer is comprised of one candle. It has one defining feature. The extensive shadow or mil to the downside!

Found at the bottom of a downtrend, this signal shows evidence the Bulls started to step in. The signal is usually formed after an extensive downtrend has been in effect. The price opens and continues to head down. However, before the end of the day, the Bulls start moving in.

One of the few formulas that an investor has to learn when analyzing candlestick signals is the length of the “shadow” or “tail.” In the case of a Ham­mer signal, the lower shadow or tail should be at least two times greater than the body. The body can be either black or white. When viewed in the oversold condition, one should watch for a bullish confirmation the following day.

The important aspect of a Hammer signal illustrates that the Bears were pushing the prices down. Then the Bulls started entering the trade. The Japa­nese say, “The Bears were hammering out the bottom.”  The term “takuri” in Japanese is defined as “searching or probing for the depths,” testing for the bottom.

The strength in which the Bulls started coming into the position is de­picted by the color of the body. The buyers stepping in at the bottom of a trend, bringing the price back up into the top third of the trading range for the day is illustrated as a hammer signal with a black body. The significance of this signal is that the Bulls have moved in.

Criteria

1.     The lower shadow should be at least two times the length of the body.

2.    The real body is at the upper end of the trading range. The color of the body is not important although a white body should have slightly more bullish implications.

3.    There should be no upper shadow or a very small upper shadow.

4.    The following day needs to confirm the Hammer signal with a strong bull­ish day.

Signal Enhancements

1.     The longer the lower shadow, the higher the potential of a reversal oc­curring.

2.    A gap down from the previous day’s close sets up for a stronger reversal move, provided the day after the Hammer signal opens higher.

3.    Large volume on the Hammer Day increases the chances that a blow-off day has occurred. (Blow-off day – see glossary)

The signal gains more strength if the Bulls bring the price back up through the open and close at or above that price, creating a white body. This illustrates more strength coming from the buyers than a black body.

What do investors want to see after a Hammer signal? Continued buying! Does that continued buying need to come in the next day? Not necessarily As will be experienced with many candlestick reversal signals appearing at the end of a downtrend, residual selling may occur for another day or two before a trend starts its move. The reversal signal indicates a change of investor sentiment. The trend, from that point, has a high probability of moving in an upward direction. However, it may take another few days to soak up the remainder of the sellers. As illustrated in Fig. 2-35 (following page), the AMB Properties chart, the large shadow to the downside is the clear reversal of the trend.

Fig. 2-36, the Celgene Corp. chart shows how one signal might have mul­tiple names. The hammer signal could also be considered a Bullish Harami. The length of the shadow is an important indicator in itself. The further the prices were knocked down and then bought back, the more convincing the reversal.

The name of the signal is less important than being able to identify that a reversal signal has formed. The long lower-shadow, forming a Hammer signal, at a major moving average, while the stochastics are in an oversold condition, are the parameters aligning for a high probability trade.

The true Hammer signal is depicted with no upper shadow or a very small upper shadow above the body. The evaluation of whether a Hammer signal is a true Hammer signal, a Spinning Top, or a Dragonfly Doji is not highly relevant

The importance of evaluating the signal is to discern whether the signal demonstrates a reversal possibility.

As witnessed in Fig. 2-37, the Golden West Financial Corp. chart, a long shadow to the downside provides the indication that a reversal possibility is in the making.

The actual description of the signal is much less important than evaluating what the formation is conveying. In addition, the analysis should include the condition of the stochastics and the presence of a major moving average. How­ever, the most foretelling attribute, the long lower shadow, should be the main consideration.

The defining element of a Hammer signal is the shadow to the downside. It illustrates that when the Bears knocked the price down, the Bulls stepped in. That same analysis can be better defined when witnessing a series of Hammer signals. Those signals produce a visual scenario that demonstrates the Bears are running out of steam. As illustrated in Fig. 2-38 the Black & Decker Corp. chart, a number of Hammers occurring as stochastics start rising illustrates that the Bulls are buying each time the Bears are trying to sell. The shadows to the downside make it clear for the candlestick investor to visualize buying support. An uptrend should be anticipated. A bullish candle, coming out of this type of trading area, should reveal immediately that the Bears have given up.