The hammer candlestick pattern is a bullish reversal pattern that is often found after the stock has declined for many days. This candle pattern can provide excellent trading signals for traders. The hammer is very similar to the bottoming tail and both of them are excellent bullish reversal patterns.
The hammer candlestick pattern looks like a "hammer". That is why it is called a hammer. The body of the candle is small but the tail is long. When you look at the pattern you have to imagine what had happened during the day. The stock declined that day only to close up higher. This tells us that the stock is rejecting and refusing to go lower. It is a picture of bullishness because what rejects to go lower will eventually move higher.
Psychologically, the bears were winning throughout the day only to realize that they were not able to make the stock go any lower by the end of the day. This causes doubts in the mind of short sellers. When the price of the stock goes above the high of the hammer in the next bars, this confirms the pattern. Many traders tend to jump in and buy this stock for a quick trade. Short sellers will also cover their shorts. That's why when a hammer forms in a support area, they tend to make the stock rally very fast.
In the chart above, MRK formed a hammer pattern near the 200 day moving average. The 200 day moving average can act as a powerful psychological reversal area. When you have the hammer candlestick pattern forming at the 200 day moving average, this is a powerful signal that the stock is going to reverse.
The hammer pattern gave traders a very nice bullish swing trade in MRK. Notice how the stock rally up for a few days. That is why you should always be aware of a stock that forms a hammer candlestick pattern.
In the chart above, you can see how AAL had a decline. Then a hammer pattern formed and it marked the bottom of the decline. From there, the stock started a new uptrend which lasted for a very long time. Some traders will jump into a stock when the stock price trades above the high of the hammer pattern. Trading the hammer pattern can give traders a very good risk reward because you never know how far a stock can run. Sometimes you only risk $1000 to be able to make $10,000. That's the power of the hammer candlestick pattern.
The chart above is an example where a hammer pattern that forms at the 50 day moving average can be a powerful reversal signal. As we all know, the 50 day moving average is a very good subjective support level. If you notice clearly, you will also see that the hammer pattern actually formed at a price support as well.
When you have a bullish reversal candlestick pattern form at a price support and 50 MA support, you can be very sure there will be a reversal soon. True enough, LEN had a bullish reversal and shot up higher the next few days. This stock gave the swing trader a very nice bullish swing trade.
LNT also formed a hammer near its 50 MA. The stock had a decline in January but it begin to form some small bodied candle that tells us that bearish momentum is slowing down. The hammer pattern marked the bottom of the decline. From there, the stock slowly drifted higher.
MOS formed a hammer after a decline in mid December. There was a big red bearish candle before the hammer formed. At that moment, there was a lot of fear in the stock. The next day, the stock tried to move lower but it eventually rose higher and formed a hammer pattern. Can you imagine the feeling of the stock holders?
Although the decline was scary, the fact that the stock could not move lower told us there were not enough sellers to push the price of the stock down. A gap up the next day above the high of the hammer confirmed this pattern. Eventually buyers step in and help push the stock price higher.
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