*Article updated on June 8, 2017*
One of the most important candlestick formations that a trader can learn is without a doubt the “Hammer” or “Shooting Star”. In a nutshell, these candles can show a potential reversal of the trend. They tend to congregate at important inflection points in the markets, and can often predict a sudden move in the other direction.
One of the main reasons they work is that so many people are familiar with them. It is probably the first candlestick a lot of traders learn. While they have different names, including “pin bar” or “pin candle”, they are essentially the same thing: a representation that exhaustion is setting in for the market and it could reverse course soon.
A Hammer and a Shooting Star
The names are used depending on what direction the market is heading. When the market has been rising, the formation is called a shooting star. When the market has been falling, it is called a hammer, because it looks like one. When you see one of these candles, it might be time to get ready to head in the other direction very soon. Having said that, let’s take a look at these formations:
Exhaustion in the Markets
As you can see from the “shooting star”, a long wick has formed above a fairly neutral finished. Neither the buyers nor the sellers took control during this candle. However, one important clue has been left behind: the long wick on top. This shows that although the buyers did manage to push prices higher, they failed to hold them up there. This shows what is known as “exhaustion” in the markets, and signifies that buyers are probably going to struggle to continue to move prices higher.
On the “hammer” candle pictured above, you can see very similar facts, except in opposite terms. The sellers did manage to push prices lower, but didn’t hold the market down there. The shows that they may be running out of conviction, and might struggle to take the market lower in the future as well.
A Swing High for a Shooting Star & a Swing Low for a Hammer
The important thing about these candles is that they be positioned at a swing high, in the case of the shooting star, or a swing low, in the case of the hammer. By being at a recent high or low, it shows that the momentum is slowing. This signals a possible change in direction as strength is waning in the recent movement. For example, it price has been climbing for weeks in the market you are trading and a shooting star appears one day, this could be a sign that the strength of the move is failing. (They all do eventually.)
The length of the wick is important as well. It shows just how far the buyers, in the case of the shooting star, actually managed to push prices – only to fail. So not only does it show the attempt, but it also shows exactly how hard the sellers pushed back! (Vice versa for the hammer.) This is an important clue as is shows that the momentum is swinging in the other direction. In fact, the longer the wick, the better.
Secrets of the Hammer
So far, so good – but it is important that we look into the hammer/shooting star formation a little more deeply. Jumping into trading with only a little superfluous knowledge about this candlestick pattern is a very popular way to blow your account, so please pay attention carefully to the following:
- In a strong trend, a hammer signifying a reversal is more likely to fail than to succeed. This is because in this situation, the price usually needs to some to turn around before it can move convincingly in the opposite direction. So if the market moves up say for 100 pips in 3 hours and then prints a bearish 1 hour hammer, it would probably be foolish to jump in straight away. A good rule of thumb is to wait for the same length of time to elapse (4 hours in this case) without a new high being printed, before you consider shorting the hammer.
- Generally speaking, a hammer is more likely to see the price continue in the direction of the wick, than reverse. This is why above I’ve said that it is very important to trade these formation as reversals only at key swing highs or lows which acted as support or resistance earlier, and also, to be more confident of hammers which are larger in range than the immediately preceding candles. One old rule of thumb which some traders like to use before trading a hammer as a reversal is for the hammer to have a larger range than any of the previous 5 candlesticks / price bars.