Inverted Hammer

 


Shape:
The inverted hammer is a bullish reversal candlestick pattern that typically appears after a downtrend.
It has a small real body located near the bottom of the candle’s range, a long upper shadow at least twice the length of the body, and little to no lower shadow.
The long upper shadow shows that buyers attempted to push the price higher but faced selling pressure; however, the failure to push the price lower suggests potential reversal strength.

Success Rate:
Historically, the inverted hammer has a moderate success rate of around 55–60%, which improves when confirmed by the next candle closing higher with increased volume.

Buy:
Enter a buy position when the price closes above the high of the inverted hammer candle, confirming bullish reversal.
Preferably, the confirmation candle should be strong and backed by high volume.

Take Profit (TP):

  • Conservative: Set TP near the next immediate resistance level.

  • Aggressive: Use the height of the inverted hammer to project the target upward from the confirmation candle’s close.
    Example: If the candle’s height is Tk.4 and the confirmation close is Tk.50, the target would be Tk.54.

Stop Loss (SL):
Place the stop loss slightly below the low of the inverted hammer candle to protect against failed reversals.

Sell:
Sell if the price fails to move upward after confirmation and instead falls below the inverted hammer’s low. Also consider selling if the price reaches TP or reversal signs appear.

Profit Trailing:
Use a trailing stop to protect gains as the price rises, adjusting the stop loss below higher swing lows or using a moving average (e.g., 20 EMA).

Lot Size:
Determine lot size based on account size and risk tolerance, ensuring potential loss does not exceed 1–2% of account equity.

Risk-to-Reward Ratio:
Aim for at least 1:2 or higher for favorable risk–reward.

Leverage:
Use cautiously to avoid magnifying losses in case of false reversals.

Other Conditions:
Best performance occurs after a sustained downtrend, at strong support zones, and with volume confirmation on the following bullish candle.

Caution:

  • Alone, the inverted hammer is not a strong buy signal; always wait for confirmation.

  • Effectiveness decreases in choppy or sideways markets.

Pros and Cons of the Inverted Hammer

Pros:

  • Early Reversal Indication: Can mark the first sign of a downtrend ending.

  • Clear Structure: Easy to visually identify due to its distinct shape.

  • Defined Entry/Exit: Entry above high and stop below low provide clarity.

Cons:

  • Needs Confirmation: Without a bullish confirmation candle, reliability is low.

  • Moderate Success Rate: Less effective compared to stronger reversal patterns like Morning Star.

  • Market Dependency: Works better in clear downtrends with oversold conditions.

Trading Psychology of Inverted Hammer

Formation:

  • Downtrend Pressure: Bears dominate, pushing prices lower.

  • Buyer Push: During the candle’s session, bulls push prices significantly higher (long upper shadow).

  • End-of-Session Pullback: Bears push prices down from highs, but cannot make a new low.

Market Sentiment:

  • Bullish Hope: The long upper shadow signals buyers’ presence.

  • Bearish Fatigue: Bears are losing control as they fail to create new lows.

Breakout Psychology:

  • Confirmation Candle: Traders wait for a strong bullish candle after the inverted hammer before entering.

  • Volume Surge: Higher volume confirms genuine buying interest.

Post-Breakout:

  • Validation: Close above inverted hammer’s high confirms reversal sentiment.

  • Profit-Taking: Some traders take profits at nearby resistances; others trail stops for bigger moves.

Failure and Risk Management:

  • False Reversals: Pattern can fail in strong bear markets.

  • Reevaluation: If breakdown occurs, traders step aside or reverse positions.