Trading the Hammer & the Shooting Star Patterns
In our previous article we made an introduction to the candlestick patterns, as well as presented the candlestick pattern known as the Doji candlestick. Summarizing, candlestick patterns are specific candlestick formations, often used to facilitate trading decisions and assist in properly reading the market. They display four pieces of information for a specific time period, in the form of a candle. The displayed information is the open, high, low and close price for the timeframe represented by the candle. The high and low points are connected with lines to the candle’s body, which is defined by the open and close prices and usually, candlesticks with a close price higher than the open price are colored in green, while candlesticks with a close price lower than the open price are colored in red. Candlestick patterns are common candlestick formations that often contain useful information for trading decisions.
In this article, we expand on more candlestick patterns and we explain how you can interpret them and use them in your daily trading. More specifically, we will discuss the hammer pattern and the shooting star pattern. We will explain how you can identify them, what they mean and how they can be traded.
What is the Hammer Pattern?
The hammer is a candlestick usually found at the bottom of bearish trends which looks like…a hammer! The hammer candlestick has a long lower shadow and a relatively small body. This means that the price moved strongly downwards during the candle period, but buyers stepped in and formed a resistance area, buying all excessive liquidity and causing the price to return close to the opening level. A hammer candlestick can be bullish or bearish and have no or a very small upper shadow. Below you can see the hammer candlestick variations.
Trading the Hammer Pattern
Hammer candlesticks are usually interpreted as bullish reversal signals. The structure of the candlestick indicates that the move towards lower prices is met with strong resistance and that buyers are coming into play and start gaining control of the situation. Hence, a hammer candlestick printed on the chart is a strong hint of trend exhaustion and a possible reversal in the price direction. The chart below shows a typical hammer candlestick.
In the GBPUSD chart above, we can observe the abrupt downward price movement that is interrupted by the hammer candlestick indicated by the red arrow. Here buyers identify an opportunity to buy the dip and step into the market, buying off all the available liquidity, with the candle eventually closing above the open price. Nevertheless, it is not wise to base your trading decisions on a single candlestick, therefore it is recommended to always confirm your signal with a supportive indicator. In the case above, it would be safer to enter the market on a MACD signal crossover, at the point marked in the chart below.
What is the Shooting Star Pattern?
The shooting star is a candlestick usually found at the top of bullish trends, which looks like a reversed hammer. The shooting star candlestick has a long upper shadow and a relatively small body. Opposed to the hammer candlestick, in the shooting star case, the price moved strongly upwards during the candle period but the movement was interrupted by a strong sell-off, causing the price to fall close to the opening level again. A shooting star candlestick can be bullish or bearish, and have no or a very small lower shadow. Below you can see the shooting star candlestick variations.
Trading the Shooting Star Pattern
In contrast to hammer candlesticks, shooting star candlesticks are interpreted most of the time as bearish reversal signals. A shooting star candlestick indicates that the move towards higher prices is met with strong sell-off pressures and some sellers are looking to liquidate their profits, something that can spark a broader sell-off of the asset. Hence, a shooting star candlestick printed on the chart is a flag for a possible reversal in the price direction towards lower market prices. The chart below shows a typical shooting star candlestick.
The price in the chart moves steadily into higher levels until it is interrupted by the shooting star candlestick indicated by the red arrow. At this point the trend loses momentum and investors start liquidating, looking to realise some profit from the previous trend. Hence, the shooting star is a strong signal of a possible broader sell-off. As the subsequent bars show, the signal, in this case, is correct and prices move quickly to lower levels. However, exactly as with the
Concluding, hammers and shooting stars are powerful candlestick patterns that provide valuable information about the current state of the market. If used correctly and combined with a trading indicator, they can be part of a successful trading strategy.
Limitations of the Hammer and the Shooting Star Patterns
Candlestick patterns like the hammer and the shooting star can generate a lot of false signals that could lead to substantial losses if used out of context. Therefore, when using strategies based on candlestick patterns, always consider the market fundamentals that currently move the market and combine the signals with other confirmation signals, like oscillators, support/resistance levels and the relevant price action taking place on the chart.
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