Key Takeaways:
- The appearance of hammer candlestick patterns could signal an upcoming reversal or that market sentiment may soon change.
- Following a protracted bearish trend, the hammer has an increased likelihood of showing a sharp market reversal.
- Because hammers provide no price target, it can be difficult to determine a trade profit.
A hammer candlestick stock pattern can help inform trading strategies, as it can signal the upcoming price movement of a security. The phenomenon occurs on timeframe charts when an asset trades markedly lower than its opening price then rallies to close near that price.
So, what exactly is a hammer candlestick stock pattern and how do traders use it?
What is a Hammer Candlestick?
Such a formation manifests when financial assets such as stocks trade significantly under their opening price, then surge to close near said price by the trading period’s end. A hammer candlestick can also signal that market sentiment is about to turn.
What Does a Hammer Candlestick Look Like?
As its name may suggest, the analytical tool looks like a hammer-shaped candlestick. It features a small upper shadow – if a shadow exists at all – where a candle’s highest price is nearly equal to the security’s opening or closing price.
Another characterization is the candlestick’s long bottom shadow, which is at least twice that of the candle’s body. This means that the lowest price is nowhere near its opening or closing price.
The candlestick’s body can either be bullish or bearish.
- Bullish. The candle’s closing price is higher than the open.
- Bearish. Here, the candle’s closing price is lower than the open.
Bullish candlesticks are typically charted in green, and bearish ones in black.
What Causes a Hammer Candlestick?
A hammer candlestick pattern forms when a security price drops then rises dramatically. It is one of the most common candlestick patterns.
How to Predict Such a Pattern
Investors should watch for such formations following price drops, since that is when such patterns typically occur.
Example of a Hammer Candlestick
Say an investor is tracking stock ABC’s price movements. Following examination of the asset’s candlestick chart, the investor notices a bullish hammer in a downward trend following four falling candlesticks. Hoping it signals a trend reversal, the investor purchases 50 shares of ABC stock at $5 each. After the buy order is placed, the security’s price increases during an uptrend. The investor sold all shares for $8 each and profited $150.
What is an Inverted Candlestick?
An inverted candlestick can be bullish or bearish.
A bullish inverted hammer has a single candlestick pattern with a long upside wick and small body. Here the security’s closing price stays above the opening price, signaling a buying pressure at closing. The bullish inverted hammer shows up following protracted downward pressure.
Bearish inverted hammers, or shooting stars, occur following a stock uptrend, as represented by an upper shadow. The shooting star rises following the opening but closes at around the same trading period level. Signaling the top of a price trend, a bearish inverted hammer is basically the opposite of a hammer candlestick.
What are Trading Strategies Associated with a Hammer Candlestick?
It is generally wise to employ stops to protect one’s position should the hammer signal play out unexpectedly. First, investors should be able to consistently spot hammer candlestick patterns.
An investor who seeks to trade in an upswing can “go long,” which means to buy. If they believe the signal is insufficiently strong and that the downtrend will continue, they can “go short” (sell).
What are the Pros and Cons of a Hammer Candlestick?
There are key benefits and shortcomings, namely:
Advantages
- Reverse signal. Following a protracted bearish trend, the hammer has an increased likelihood of showing a sharp market reversal.
- Exit signal. Traders with a short position can use the hammer candle as a sign that selling pressure is receding, creating an optimal time to close out of that position.
Disadvantages
- No guaranteed continuation of upside movement. A candlestick’s appearance following a long bearish trend notwithstanding, the stock’s price might decrease.
- No price target. Because hammers provide no price target, it can be difficult to determine a trade profit.
What Does this Mean for the Market?
The appearance of hammer candlestick patterns could signal an upcoming prospective reversal or that market sentiment is soon to change.
How are Investors Usually Affected by this Pattern?
Traders commonly use the pattern as a tool to identify potential price trend reversals. Investors who integrate the pattern into their strategy could improve trading results. However, they must fully grasp the pattern’s characteristics and know how to find it in a price chart.
What are Other Common Types of Stock Patterns?
There are other types of stock patterns including:
- Triangle
- Cup and Handle
- Double bottom
- Falling wedge
- Uptrend wedge
- Bullish engulfing
- Trend line
- Double top
- Double bottom
How to Invest Outside the Stock Market
There are investment opportunities beyond the stock market that do not cause as much stress because they are not moored to an intrinsically volatile stock market.
Increasingly, such opportunities include alternatives – assets that do not fit into conventional categories of equity, income, and cash. Such investments include art, real estate, commodities, hedge funds, and more.
Alternatives can generate consistent secondary income while diversifying one’s investment portfolio. Afterall, diversification is key to successful investing.
Alternative Investments and Portfolio Diversification
Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform. However, that meant the potentially exceptional gains these investments presented were also limited to these groups.
To democratize these opportunities, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
Learn more about the ways Yieldstreet can help diversify and grow portfolios.
Summary
It is important for investors to understand the hammer candlestick stock pattern and how it is used. While traders should not rely on it alone to determine likely price direction, such a pattern can signal a looming change in market sentiment.
It is also important for investors to be aware of investment options that are not directly tied to the ups and downs of the stock market.
All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.
What's Yieldstreet?
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.
2 Represents an net annualized return, using an internal rate of return (IRR) methodology, with respect to the matured investments shown in your Portfolio experience, utilizing the effective dates and amounts of subscriptions and distributions to and from the investments, net of management fees and all other expenses charged to the investments.[read more]