There are simple as well as complex candlestick patterns that are used by traders to identify trend reversal as well as trend continuation. Candlestick charting has become one of the most important tool in the trading arsenal of any trader. Almost all the trading platforms now have candlestick charts in their menu. One candlestick pattern does not occur frequently but when it does it means that the trend will reverse itself soon is the Inverted Hammer.
An Inverted Hammer is a quite rare pattern as the price action needed to produce it does not takes place frequently. But if it does, it is an important signal that you shouldn't ignore. Now an inverted hammer can get formed in a downtrend as well as an uptrend. In a downtrend, the first day is a bearish candle signalling that the bears are still in control of the market.
How to identify an Inverted Hammer? Identifying an Inverted Hammer is not difficult. It looks just like an inverted hammer! What this means is the high of the trading day is way above the body. So most of the trading took place close to the small area near the low. Now, this low serves as the support for the coming days. An Inverted Hammer has a very small body at the bottom of the candle with a long wick on the upside.
But before trading on an inverted hammer signal, you need for the confirmation on the following day. Now, if you find the open of the next day higher than the low of the previous day, the inverted hammer pattern formed last day was a true pattern. You can now trade this inverted hammer pattern by placing a stop close to the open of the day.
Now, let's talk about an uptrend. Identifying an Inverted Hammer in an uptrend is almost similar to a downtrend. When an inverted hammer is formed in an uptrend, it means that the uptrend is about to reverse itself into a downtrend. On the first day, you will find the usual bullish candle signalling that the bulls are in control of the market. This is followed by a gap opening and more buying.
But soon the bears start to take control of the market and push the prices down. The close of the day is equal to or close to the low of the day. When you idenfity a bearish inverted hammer pattern, you can safely go short by putting a stop near the open of the signal day or the day when inverted hammer was formed.
Once, you have placed the stop, you have limited your risk. In case, the market moves in the direction as anticipated, you make a nice profit. Placing a stop loss is very important in trading risk management. If the subsequent price movements do not confirm the inverted hammer, the stop loss comes into action and takes you out of the market at an acceptable loss. If you are an aggressive trader, you can place the stop loss close to the high of the inverted hammer.
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