Inverted Hammer

The Inverted Hammer describes the shape of one candlestick but in order to use it properly, one needs to consider it like a Morning Star, i.e. as a three-candlestick bullish reversal pattern.

The 2nd candlestick, the star itself, is an Inverted Hammer. This bullish reversal pattern is less powerful than a Morning Star.

Its characteristics are as follows:

• The Inverted Hammer must appear after a downtrend.

• The 1st candlestick must have a red body.

• The 2nd candlestick should be an Inverted Hammer; it should preferably form a gap down and ideally have a green body.

• The 3rd candlestick should ideally form a gap up and have a long green body.

Such a pattern appears after a downtrend, the day after losses happened, when prices open gap down, then rise and fall again before finally closing at almost the same level as they opened. The day after, prices open gap up and rise to win back most of what was lost in the 1st gap. This confirms the pattern and the major force is now bullish.

It is worth mentioning that the Inverted Hammer is less powerful than the Morning Star since prices open at their lows in the 2nd candlestick which is the Inverted Hammer, they then rise and fall again which shows that the bulls are not strong enough yet. The body of the Hammer should preferably be green as this shows that the bears have not been able to make prices go down to their lows. A red body is still acceptable though.

The wider the 2nd gap, the more significant the pattern is. The more losses from the 1st candlestick and gap are erased by the 3rd candlestick, the more significant the pattern. Strong volumes on the 3rd candlestick can also confirm the pattern.

Since the Inverted Hammer is less powerful than the Morning Star, the validation of the pattern is of high importance. If it is validated or other bullish signals reinforce it, the pattern can give rise to buys on D+2 (D being the day of the Inverted Hammer and D+1 that of the green candlestick). The invalidation threshold can be placed either below the lowest point of the pattern, or below the 2nd gap if there was one and depending on the investment intentions of the stakeholder.

Moreover, it is interesting to observe both reversal patterns and support and resistance lines. An Inverted Hammer can thus appear around a support and even go through it momentarily without invalidating it, as this is precisely the case in the example with 4500 points and then give rise to a bullish reve.