Inverted Hammer Pattern

Description

The Inverted Hammer incorporates the reverse interpretation of the Hanging Man signal. Found at the bottom of a downtrend, this shows evidence the Bulls started to step in, but that selling was still going on. After a downtrend has been in effect, the atmosphere is very bearish. The price opens and starts to trade higher. The Bulls have stepped in. But they can’t maintain the strength. The existing sellers knock the price back down to the lower end of the trading range. The Bears appeal* to still be in control. It has the aspects of being a bearish signal.

The mental effect of the Inverted Hammer creates cause for concern for the bears. Although the price closes back down near the low of the day, the buying that day had the Bears worried. The next day, if prices open higher, the Bears are thinking, “darn, the Bulls are still at it.” If the Bears see that the Bulls are being persistent, they start getting out of the way. The higher the price moves up before being pushed back down, the more consternation it will have caused for the Bears.

The Inverted Hammer is comprised of one candle. It is easily identified by the presence of a small body with a shadow at least two times greater than the body. The color of the small body is not important but a white candle has slighdy more bullish implications than the black body. A bullish candle is re­quired the following day to confirm this signal.

The signal is also a very high probability signal. It does not occur as often as most of the other major signals, but when it does, it will usually produce positive trade results. It also provides an excellent stop loss format. Purchasing a position on a positive open on the following day is the correct entry process. However, if the price would then close below the low point of the Inverted Hammer, a simple deduction can be made. The Bulls were not in control. Close it out immediately.

Criteria

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

2.   The real body is at the lower 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 lower shadow or a very small lower shadow.

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

Signal Enhancements

1.    The longer the upper 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 lower.

3.   Large volume on the Inverted Hammer Day increases the chances that a blow off day has occurred.

The most informative factor conveyed in an Inverted Hammer signal is the fact that the buying started. Although the sellers appeared to have maintained con­trol by the end of the day, the Bears had noticed that some buyers had gained confidence in this price area. This may have caused a tinge of doubt to come into the Bear’s thinking. The bearish sentiment that may have been stronger in the earlier parts of the downtrend should now create some questions.

A gap up in price clearly indicates that the bullish sentiment is definitely in control. The probabilities become extremely high that an uptrend is in process when the prices gap up following the signal. The definition of a gap up in the case of the Inverted Hammer would be a price opening above the body of the signal. That could mean the price opening up in the upper shadow area or above the high of the Inverted Hammer trading range. Of course, the higher the next day’s open, the greater the probability that the uptrend will show strength. Fig. 2-64, the Nextel Communications chart reveals a positive open, although a Doji day, it still revealed the buyers coming into the price again.

The candlestick investor, understanding what this signal is doing to the psy­chology of the Bears, can now be prepared. If the bearish sentiment is waning, as indicated by an Inverted Hammer signal, then the bearish sentiment should become less pronounced upon seeing more buying. A position entry strategy becomes simple. If the price appears to be opening positive following the In­verted Hammer, the candlestick investor can start buying immediately.

If the eye becomes trained to recognize the signals, then it produces a format for entering trades at the optimal entry areas. The key word in this statement is areas. Most investors allow ego to dictate an entry strategy. The sense of pride for entering a trade at the absolute lowest point becomes an overriding factor. What most investors forget is that investing is for the purpose of maximizing profits. The challenge of getting into a trade at the lowest pos­sible entry level diminishes the effectiveness of a good investing program

Fig. 2-65 the Arvinmeritor Inc. chart demonstrates an Inverted Hammer acting as a Harami signal also.

The candlestick signals are a function of a change in investor sentiment. Not a function of anticipating where the absolute bottom will be. The Health Net Inc. chart illustrates what an Inverted Hammer foretells. The appearance of the signal implies that the buyers have stepped in at what could be perceived as the bottom. Will that necessarily mean the uptrend will start immediately? Some­times, it does, sometimes it doesn’t. But what it does demonstrate is that buying started, probably putting an end to the downtrend.

The candlestick investor is anticipating strong buying indications. Even though the buying may not appear immediately, the fact that the Inverted Ham­mer appeared indicates a change in investor sentiment should be experienced soon. Fig. 2-66 the Health Net chat illustrates that the Inverted Hammer signal was the first signs of the buyers stepping in. It took a few days for the remain­ing selling to be finished.

The same illustration can be seen in Fig. 2-67, the Broadcom Corp. chart. Al­though the trading following the Inverted Hammer signal did not reveal dra­matic strength immediately, it eventually acted as the bottom. The shadows to the upside indicate buying, which needs to be included into the visual analysis. Something in investor sentiment is changing. That knowledge gives the candle­stick investor an advantage. The Japanese Rice traders viewed this signal for centuries. Understanding the psychology that creates a signal aid an investor to understanding what is expected in the trend results.