Inverted Hammer as a market analysis tool
The inverted hammer is a candlestick pattern that forms in the final stages of a downtrend. Traders view this pattern as a sign of a potential market reversal. Its appearance indicates a significant price jump and that the investor has failed to gain a foothold at the top.
The pattern is the shape of a candle with four elements:
– body;
– long upper shadow (wick);
– short lower shadow;
– interrelation of elements with resistance and support levels.
The inverted hammer can appear on the chart after a price drop, signalling a long position. The wick indicates price growth during the trading session. However, it returns to lower levels under pressure from the bears.
Patterns are an important part of technical analysis. Traders perceive their appearance as a signal to buy actively. The effect of a pattern is strengthened by stable growth in trading volume. The frequency of its formation depends on the type of asset and market characteristics. For example, the pattern is more likely to form in markets with high volatility. We are talking about operations with currency pairs, cryptocurrencies, or shares of small companies.
Advantages and disadvantages
As with any other technical analysis tool, there is a recommendation to use it with other technical analysis tools. Traders appreciate its advantages:
1. Bullish reversal indicator: helps to identify entry points in the market after a downward trend.
2. The pattern is easy to identify on the chart – its shape is different from other candlesticks.
3. The signal helps to analyse the market sentiment. It indicates the possible dominance of the bulls.
4. In combination with other instruments, the hammer gives more accurate and detailed information about trends.
At the same time, the pattern has a number of disadvantages that you should take into account when using it:
1. When used alone, it has low reliability. It requires confirmation with the help of other indicators.
2. The effectiveness of the inverted hammer is sensitive to market trends and fluctuations in sentiment.
3. In volatile markets, the likelihood of false signals increases.
Considering the chart’s advantages and limitations, experts recommend supplementing it with other methods of technical analysis. The most effective are support and resistance levels. It is also important to think about the general market background and the sentiment of market participants. This will allow you to get more accurate signals and make more informed trading decisions.
In this case, the trading strategy is to open positions after confirming the trend reversal. Traders are advised to place buy orders above the maximum level marked on the chart. Taking into account the volatility of the asset, they place a stop loss below the minimum level.
