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The Hammer Trigger for Bullish Reversals

By , Forex Trading Instructor
02 October 2013 19:00 GMT

Article Summary:

  • Traders can utilize Price Action in an attempt to find short-term reversals in markets
  • In this article, we touch on five of the most common Bullish Reversal patterns
  • Multiple Time Frame Analysis can be used to trade reversals in direction of longer-term trend

In our last Price Action article, we looked at trading Bearish Reversals in the Forex Market. In this article, we’re going to go over some of their bullish-counterparts, with specific focus on the hammer formation.

But rather than just show some candlestick setups, we’re going to try to take this a step further, as we have with all of our Price Action articles, in explaining the rationale for ‘why’ these setups are important for traders to recognize.

If you would like a guide for how reversals should be treated, please don’t hesitate to check out any of our previously published resources on the topic. Trading Bearish Reversals supplies a model that traders can utilize in reverse to trade in bullish scenarios; and the article ‘Trading Reversals’ will provide a much more high-level view on the topic of reversals in general.

The Hammer

The Hammer formation is probably one of the more telling bullish reversal formations that traders can find in markets, and it’s also one of the formations that will most ‘stand out’ to traders.

The Hammer has a long wick on the bottom of a Bullish candlestick

Taking_Hammers_for_Bullish_Reversals_body_Picture_4.png, The Hammer Trigger for Bullish Reversals

Created with Marketscope/Trading Station II

The hammer formation tells the trader quite a bit. During this candle’s formation, prices ran down quickly, only to reverse. And not only did prices reverse, but they reversed beyond their initial opening price, thereby creating a bullish candle.

This setup can be especially attractive if the long wick on the bottom of the candle is sitting outside of previous price action. In the picture below, we look at the same hammer formation that we looked at in the above graphic; but this time we’re going to look at the formation with some context:

A Bullish Hammer to trigger in direction of previously established trend

Taking_Hammers_for_Bullish_Reversals_body_Picture_3.png, The Hammer Trigger for Bullish Reversals

Created with Marketscope/Trading Station II

Notice in the above picture on the British Pound against the US Dollar, a nice and strong up-trend had formed before running into a retracement (in red).

During the retracement, a hammer formation forms (the same candle we looked at in each of the previous two illustrations).

Traders can look at this an entry opportunity, looking for the previously established trend to continue in that direction.

Traders can look to enter once the hammer formation has completed (the candle has closed), with a stop just below the low of the hammer’s wick.

If the previously established trend comes back, the trader can look for 2, 3 or even 4 times the amount they are risking at the outset of the trade.

Inverted Hammer

The inverted hammer is another bullish candlestick formation that will often be found at or near the bottom of a retracement in an up-trend.

The inverted hammer is opposite of the hammer formation, in the fact that the bullish body of the inverted hammer is at the bottom of the formation, with a long wick sitting atop the body. The picture below will illustrate further:

The Hammer formation shortly before an up-trend sets in the market

Taking_Hammers_for_Bullish_Reversals_body_Picture_2.png, The Hammer Trigger for Bullish Reversals

Created with Marketscope/Trading Station II

The inverted hammer is often found at the bottom of a move, and will indicate a potential reversal in the near-term trend. The logic of this candle is similar to the logic of the hammer. During this candle’s formation, prices ran high, but sellers came in to bring prices lower before the candle completed.

Inverted Hammers v/s Shooting Stars

Many traders will often confuse the inverted hammer formation with the ‘shooting star’ formation that we looked at in our last article, Trading Bearish Reversals.

The Shooting Star formation as shown in Trading Bearish Reversals

Taking_Hammers_for_Bullish_Reversals_body_Picture_4.png, The Hammer Trigger for Bullish Reversals

Created with Marketscope/Trading Station II

There are some key differences to note between these two formations. Firstly, the shooting star is bearish, while the inverted hammer is bullish; and as such, the shooting star candlestick should be bearish, and the inverted hammer should be bullish.

But perhaps more importantly is the context of the market at the time of formation.

Shooting stars take place at the top of a move. And just like we looked at in Trading Bearish Reversals, trading shooting star formations is optimal in longer-term down-trends, with a near-term retracement (up-trend). This way the trader can look to the shooting star formation to initiate a short position for a reversal in the near-term up-trend, and a continuation in the longer-term down-trend.

The inverted hammer works similarly.

As a reversal formation, the inverted hammer should be found at the bottom of a move. But, once again, this can be a near-term down-trend or retracement, found within the longer-term up-trend. The trader can use the inverted hammer to trigger into the position, looking for the longer-term trend to continue, while playing the reversal of the near-term retracement.

If you would like more information on this style of trading, our article covering multiple time frame analysis can assist in helping traders separate longer-term trends, from near-term movements.

-- Written by James Stanley

James is available on Twitter @JStanleyFX

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Would you like to get better with Price Action? Please feel free to take our 15 minute course on the topic. You’ll first be asked to sign the guestbook, which is completely free; and then you will be met with the video-based lesson via Brainshark.

Price Action Presentation via Brainshark

We’ve recently begun to record a series of Forex Videos on a variety of topics. We’d greatly appreciate any feedback or input you might be able to offer on these Forex videos:

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02 October 2013 19:00 GMT