The hammer is a bullish figure of reversal that occurs after a downtrend.
The elements that characterize it are:
- The hammer should appear after a downtrend.
- The upper shadow should be almost nonexistent.
- The body should be small and on top part of the candlestick. It may be green or red but ideally green.
- The lower shadow should be longer and ideally represent more than two times the length of the body.
- Rates must create a new low against the previous candlestick.
In the example here all these conditions are met and a reversal occurs.
This type of Japanese candlestick is formed when, following a downward trend, the rates create a new low but then they go back to close near the opening level. This shows that upward force is emerging. It is preferable that the body is green because it means that the course in the end managed to close above the opening level which bodes well for the next session.
The bigger the lower shadow, relative to the body size, the weaker the upper shadow and the more the hammer will be significant. High volumes may also come in confirmation of the figure.
Whatever the quality of the hammer, it is better to wait for confirmation of the figure by the candlestick, which should open with an uptrend, if you want to buy at J+1 (J being the day of the hammer) or green if you prefer to wait for the next closure and buy at the opening of J+2. One can further note, on the same graph, another hammer at J-11 which was not confirmed by the next session.
The threshold for invalidation may be placed either below the lowest of the hammer, or by the quarter method, according to the investment horizon of the bidder.
On the other hand it is interesting to combine the observation of the figures with the lines of support and resistance. A hammer may sometimes be formed at a support. Rates can, in some cases, even go under the liner during the session but if closure occurs above the support, the break will not be validated and we may see a reversal on the support, like the one occurring in the example at 7500 points.