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The hammer candlestick emerges at the bottom of a downtrend and signals that the market is likely to turn bullish. The most common is the bullish hammer candle, which has a small candle body and a lengthy lower wick, suggesting rejection of lower prices. Another pattern that traders look for is the inverted hammer, which is an upside-down bullish hammer.
Bullish Hammer Candlestick
The hammer candlestick emerges at the bottom of a downtrend and indicates a bullish trend reversal. The hammer candle has a tiny body, little or no top wick, and a long bottom wick, giving it the appearance of a hammer.
The pattern suggests that the price sank to new lows, but subsequent purchasing pressure propelled it to close higher, indicating a possible turnaround. The prolonged lower wick indicates a rejection of lower pricing.
An inverted Hammer Candlestick
Like the bullish hammer, the inverted hammer candlestick suggests a bullish reversal. The candle, as the name suggests, is an inverted hammer. The candle has a long extended top wick, a small true body, and no or very little bottom wick.
As seen by the extended upper wick, the candle opens near the bottom of a downtrend before the bulls propel the price upwards. Price eventually returns to the initial level, but closes above it, indicating a bullish signal. If the buying tendency continues, the price action will rise in the next few days.
Hammer candles have their advantages and their limitations;
Advantages
Reversal signal: The pattern implies that lower prices are being rejected. When seen in a downtrend, it may indicate the end of selling pressure and the beginning of a sideways or upward trend.
Exit signal: Traders who already have a short position might use the hammer candle as a hint that selling pressure is easing, giving an opportune moment to close out of the short position.
Limitations
No indication of trend: Because the hammer candle does not take the trend into account, it might produce a deceptive signal when seen in isolation.
Supporting evidence: When entering high-probability trades, traders should seek for extra information on the chart that supports the argument for a reversal. Such confluence may be identified by determining whether the hammer appears at a big level of support, pivot point, significant Fibonacci level, or an overbought signal on the CCI, RSI, or stochastic indicator.