The Power of the Hammer
I get asked all the time, “I thought you only trade hammers?”. My answer is always the same… “I do only trade hammers!”. That is if I’m playing a candle pattern. This usually begins a round of challenge questions reflecting on some of my trades in which I am met with the same scepticism as always. That’s not a hammer, it’s a double bottom.
The hammer is my favourite candle in technical analysis. The sentiment behind a hammer is very strong. Let’s first look at what a hammer is. It is defined as a candle either black (or red) or white (or green) in which the body is small and located as close to the top of the range. It has a small body in relation to its overall range and is accompanied by a long lower shadow. A hammer can have a small upper shadow or not. I personally prefer a hammer with a small upper shadow.
Now that we have defined what a hammer is, let’s take a look at the sentiment required to form such a candle. A candle opens and as time passes the sellers manage to push the price of the stock to a good lower price, initially showing strength of selling. This puts in a low for that time frame. At some point during this time, buyers step in and overtake the sellers, pushing price back up towards the top of the range. We now have a high for this time frame.
When I think about a hammer candle, I envision a tug of war in which the buyers and the sellers are battling things out. When the time is up, the bulls have overtaken and essentially beaten the bears. I consider this a strong sign of bullish sentiment. Of course, I also take into consideration the location of this hammer as well as the overall liquidity and volume of the stock I am evaluating. Depending on these factors, the sentiment behind the hammer is significantly increased.
This still doesn’t explain why some of my trades are challenged as not being “hammer trades”. Now we get into the fun stuff. What I’m about to demonstrate is known as candle math. If the word “math” turns you off or heightens a sense of anxiety in you, hang in there… this is going to be fun and easy. Let’s take a look.
This candle pattern is known as a bullish engulfing pattern. It’s defined by a bearish candle of decent size at the bottom of a trend followed by a bullish candle that completely “engulfs” the prior bearish candle and closes above the high of the prior bearish candle. Let’s take a look at the open, close, high and low of these two candles combined. If you extend the open, close, high and low to the right and then create a single candle, you may be surprised to find a hammer candle staring at you. If that doesn’t excite you, let’s take a look at another pattern.
This candle pattern is known as a piercing line pattern. It’s defined as a bearish candle of decent body size at the bottom of a trend followed by a bullish candle that engulfs the bottom half of the bearish candle and closes well into the bearish candle. Again, let’s consider the open, close, high, and low of the two candles that make up this pattern. Extend those points to the right and again, you may be surprised to find another hammer candle. Still don’t have you convinced…
This candle pattern is known as a bullish harami pattern. It’s defined as a bearish candle of decent body size at the bottom of a trend followed by a bullish candle that is completely on the inside of the prior bearish candle. Considering the open, close, high and low, extending these points to the right, again reveals a hammer candle.
For a final two candle pattern example in my attempt to wow and convince you, let’s look at the one white soldier. This candle pattern is defined by a bearish candle of decent body size at the bottom of a trend followed by a bullish candle that opens somewhere within the body of the prior bearish candle and closes above the high of the bearish candle. Considering the open, close, high and low, let’s extend the points to the right. You got it, another hammer is revealed.
Not all of these candle patterns develop into a hammer candle all the time. The size of the second candle could potentially close well above the high of the previous bearish candle that it creates a body that is too large to be considered a hammer candle. So I don’t play all of these patterns all of the time, but I do consider playing them when they combine to form a hammer.
For a bonus, I want to now look at the common double bottom pattern. If you consider the time in which a double bottom is formed and let’s say it takes seven five minute candles to form the double bottom, the time passed would be thirty-five minutes. Let’s look at the open, close, high and low during this time and as you may have guessed by now, you bet, another hammer is revealed.
The ability to look at candles and see them combining is an art and a skill that will serve you well. Seeing two candles on a five minute chart form a hammer when combined may not be evident while looking at a 10 min chart. It takes two five minute candles to make up one ten minute candle, but depending on which two candles are being combined in that calculation, the hammer may be hidden from view. Having the ability to see this formation on a lower time frame, opens up many opportunities that would otherwise be unavailable to you.
By now you should know why my answer is always the same. I only trade hammer candles. It is, in my opinion, the most powerful candle in technical analysis. With time and practice, this is a skill anyone can learn. Have I convinced you? Are you now a hammer candle trader?