Hammer - price action pattern

The Hammer

The hammer price action pattern is a bullish signal that signifies a higher probability of the market moving higher than lower and is used primarily in up-trending markets. Here is an example of what a hammer candle looks like:

A hammer shows sellers pushing the market to a new low. However, the sellers are not strong enough to stay at the low and choose to bail on their positions. This causes the market to rally back up, leading buyers to also step into the market. The open and close price levels should both be in the upper half of the candle. Traditionally, the close can be below the open but it is a stronger signal if the close is above the opening price level.

In the above price action forex chart of EUR/USD, there are two examples of a hammer pattern highlighted in the gold boxes. Through the analysis of the open, close, high and low price levels the pattern suggests a move higher is likely. In these highlighted examples, price did move higher after the candles formed. Of course, this will not always be the case and there are even examples of this in the same chart. However, how could you have traded these highlighted indicators?

THE ENTRY: A possible price level to enter a trade, could be when the next candle finally manages to break the high of the hammer candle. The high of the second highlighted hammer candle above - which formed on the week of 16 February 2020 - is 1.0863. Therefore, an entry price could be 1.0864.

THE STOP-LOSS: A possible stop loss level could be at the low of the hammer candle. If the market triggers the entry price but no other buyers step in, it's a warning sign the market may need to go lower for any buyers to be found. Therefore, you would not want the stop loss to be too close to your entry. With the low of the hammer candle at 1.0777, a possible stop loss could be 1.0776.

THE TARGET: There are multiple ways to exit a trade in profit such as exiting on the close of a candle if the trade is in profit, targeting levels of support or resistance or using trailing stop losses. In this instance targeting the previous swing high level would result in a target price of 1.1095.

THE TRADE: With an entry price of 1.0864 and stop loss of 1.0776 the total risk on the trade is 88 pips. Trading at 0.1 lot would mean that if this trade triggered the entry price, then hit the stop loss, the overall loss would be $88. In this instance, the market traded higher to the target price resulting in an approximate trade profit of $231.