The Basics of a Hammer

A hammer is a very simple candlestick, but it has a lot of influence and forecasting ability. Hammers coincide with the hanging man candlestick, which is exactly the opposite of a hammer. A hammer usually appears at the bottom of a chart and is marked by a short positive body with a long descending shadow below it. They live up to their name: you'll know them when you see them.

A hammer is a very promising sight to a trader, especially after a long-term downtrend, as this is when they are most indicative of a reversal. The long shadow at the bottom indicates that there is plenty of support below the current price, possibly even wiping out a few short positions. Long shadows show that the security dropped in price, but support prevailed.

How hammers work

In a downtrend, the hammer usually marks the end. It isn't common for an uptrend to occur immediately after a hammer, as usually a sideways trend follows for a few candlesticks before a breakout. It takes the trading discipline of a professional trader to wait out a bottom before the move upward begins. The mere discipline to wait for a trend is what separates unprofitable and profitable traders.

Creative techniques for mastering hammer candlesticks are abundant. Professional traders often wait for a fundamental change to enter a position, or wait for a modest breakout. Others attempt to find hammers then follow up with another pattern before entering. As always, a confirmation, even if small, should be found before entering. Chasing a position rather than placing a position is deadly.

When hammers don't work

If the hammer isn't near the bottom of a chart, it's probably a false signal. A hammer at the top of an uptrend could actually mean weakness after showing how much resistance exists at that level. Likewise, hammers in a sideways trend are equally worthless and may be the result of rapid up and down trading, rather than a bullish signal. Hammers are never very effective in slow markets, as the amount of support it shows will fade over time.

The perfect candlestick

Profitable traders know the power behind the textbook candlestick pattern. A few variables in the candlesticks and charts can make all the difference between a power play and a false signal. Traders should look for growing volume after a candlestick, especially after a long downtrend. A gap up after a candlestick pattern often proves profitable, as the new gap provides even more support. Stronger relative strength also shows that the market is strengthening in the direction of the hammer.

Learn how to master day trading by downloading two of Trading EveryDay's FREE products: Tools of the Trade eBook and a Trading Plan Planner. Dedicated to helping people become profitable traders , Leroy Rushing, a professional day trader, trading coach, and author, is the CEO of Trading EveryDay, a distinguished provider of educational trading products and services.