Trading The 'HAMMER'
The 'Hammer' Trade
The Hammer Trade is a trading strategy that I've been using for years to help set up and place super high probability stock and option trades.
In addition, it's a strategy that can also be easily 'plugged in' and used with a variety of different option income strategies as well - including credit spreads, debit spreads, covered calls, as well as directional calendars, diagonals, and butterflies.
When used correctly, this strategy can help quickly and easily find and identify high probability entry and exit points for a wide variety of different types of trades - as well as areas where potential trade adjustments might need to be made - and it does it using a specific type of Candlestick Chart Pattern.
What Are Candlesticks?
Candlestick Charts are a specific type of charting method with origins from centuries old Japanese rice trade.
Many traders and investors prefer using candlestick charts over standard line or bar charts because the way that candlestick charts are constructed can help make a chart much more visual and easier to read.
The reason they are called ‘Candlesticks’ is due to how they appear visually on the chart - as small ‘candles’ with ‘wicks’ sticking up and down from the top and bottom of each bar - appearing as ‘candlestick wicks’.
If you were to set up a daily stock chart using candlesticks, each daily bar - or ‘Candlestick’ - would represent one day - and the various parts of each candlestick would reflect what happened with price action throughout the course of that one day.
Here below are 2 examples of candlesticks...
The first one below is an example of a ‘Bearish Candlestick’ - or a candlestick showing a ‘down day’ (see example below)...
And here below is an example of a ‘Bullish Candlestick’ - or a candlestick showing an ‘up day’ (see example below)...
How To Read Candlesticks
When you look at a stock’s candlestick you are able to see 4 different important pieces of information:
1. The OPENING PRICE - which is the price that the stock opened at the beginning of the trading day.
2. The CLOSING PRICE - which is the price where the stock closed at the end of the trading day.
3. The HIGH FOR THE DAY - which is the highest trading level that the stock traded throughout the entire trading day.
4. The LOW FOR THE DAY - which is the lowest trading level that the stock traded during the entire trading day.
See examples below...
The COLOR of each candlestick ‘body’ can usually be customized in your charting platform - however typically the color for each candlestick is set to either RED, BLACK, or FILLED for down days - and for up days, the color of candlesticks are typically set to either GREEN, WHITE, or HOLLOW.
Using Candlesticks To Gain A Trading Edge
Candlestick Charting can be used by traders to help identify market sentiment, trends, potential turning points and reversal areas on a charts, as well as high probability bullish / bearish signals and entry and exit points - and personally I’ve found that specific candlestick bars, formations, and patterns can help me gain a significant trading edge.
One particular candlestick pattern that I’ve used with great success to help identify reversal areas and ideal entry points is a candlestick pattern called ‘The Hammer’.
The ‘Hammer’ is a bullish candlestick trading pattern which can help identify an area on the chart where a stock that has been moving downwards has reached the bottom of its ‘down move’ and is potentially positioned for a trend reversal.
Here is an example of what a Hammer Candlestick looks like (see example below)...
Hammer Candlesticks will usually occur after a price decline.
They have small candlestick ‘bodies’ - which can be either bullish or bearish - and they have long lower shadows that are at least 2 times the height of the body.
Hammers indicate a potential end to a down move - as they visually represent sellers coming into the market in an attempt to push the stock down - however by the end of the day the selling becomes exhausted and buyers push the price of the stock back up towards where it opened (see example below)...
Hammers can help identify potential reversal areas in a stock’s movement as well as entry points for an expected move back up - however a conservative trader will want to first wait for a ‘Confirmation Bar’ before going long.
Waiting For A Confirmation Bar
While an aggressive trader might use only the Hammer Candlestick bar to make a trading decision - a more conservative trader will usually wait for a follow up ‘Confirmation Candlestick Bar’ to appear on the chart before going long.
A Confirmation Candlestick Bar occurs when a Candlestick Bar following the Hammer CLOSES ABOVE the closing price of the Hammer Candlestick Bar (see example below)...
Then, once a new Candlestick Bar closes ABOVE the closing price of the Hammer Candlestick - ‘Confirmation’ has occurred and traders can set an automatic entry order either at or just above the high of the Confirmation Bar (see example below)...
If the next day's price continues to rise and moves above the high of the Confirmation Bar, the automatic entry order will be triggered and the trade will be placed (see example below)...
Then, once a trading position IS entered, the trader can set an automatic stop loss order - for example just below the low of the initial Hammer Candlestick's lower wick (see example below)...
In the example trade below, the bullish move continued and the trade would have done very well (see example below)...
The Hammer Strategy is one of my main 'go to' methods for finding high probability entry points for both stock trading strategies and option trading strategies and over the years it has given me great success.
However, like any trading method it's not 'guaranteed' or 'fool proof' and at times it can give off false signals - which is why it's important to always have patience and wait for confirmation, use it in conjunction with other valid indicators, and always have appropriate stop losses in place.
Here's A Video Below That Shows How To
Scan For Potential Hammer Trades...