Inverted Hammer Candlestick Pattern | Definition, Examples & Trading

The inverted hammer is a green single-candle pattern with a long upper wick, a small body near the bottom of the candle, and little to no lower wick, which appears in a downtrend, signaling a possible bullish reversal.

How Is the Inverted Hammer Candlestick Pattern formed?

This candlestick typically forms after a sustained price decline and indicates that buyers are starting to take control after a period of selling pressure. When you see an inverted hammer, you can often anticipate a shift in market sentiment, especially when combined with other confirming signals.

To understand how the inverted hammer is constructed, we would like to give you a detailed breakdown below.

What is a Green Inverted Hammer?

A Green Inverted Hammer is a candlestick pattern that typically signals a potential trend reversal from a downtrend to an uptrend.

The “green” color refers to a bullish candlestick, meaning the price closed higher than it opened, signaling that buyers were able to push the price higher, despite initial selling pressure.

This pattern suggests that although the market was pushed lower during the session, there was significant buying strength, as evidenced by the long upper shadow. 

In other words, the Green Inverted Hammer is considered a strong bullish signal when it appears after a downtrend, as it indicates the potential end of the bearish trend and the beginning of upward momentum.

What is a Red Inverted Hammer?

A Red Inverted Hammer looks similar to the green version, but has a small red (bearish) body, meaning the price closed lower than it opened. 

Despite the close being below the open, the presence of a long upper shadow suggests that bulls were able to push the price higher during the session, although the bears ultimately regained control by the close.

While a Red Inverted Hammer might indicate the start of a reversal or an upcoming consolidation phase, it’s generally considered less reliable as a bullish signal compared to the green version. 

When does the Inverted Hammer Pattern Appear?

The Inverted Hammer pattern typically appears after a downtrend or a prolonged period of bearish movement, signaling that the market could be poised for a reversal. 

It tends to form after a sharp decline or a series of bearish candles, suggesting that sellers may be losing momentum and that buyers are beginning to regain control.

It’s important to look for the pattern near support levels or price floors, as these areas are where a reversal is more likely to occur. 

Additionally, confirming signals from other technical indicators, such as volume spikes or bullish patterns on higher timeframes, can enhance the reliability of the signal.

What does the Inverted Hammer Candlestick Pattern Indicate?

The Inverted Hammer candlestick pattern indicates a possible reversal of a current trend. In the case of a downtrend, it suggests that despite selling pressure (indicated by the long lower wick), buyers were able to push the price back up, causing the close to be near the high of the session.

Psychologically, the pattern can be understood as indicative of a tussle:

• Bears vs Bulls: The formation of the Inverted Hammer shows a battle between buyers and sellers (bears initially controlled the market, driving the price lower, but buyers regained strength, pushing the price back up before the close)－this shows a shift in sentiment, where the bears are losing control, and the bulls are starting to make a comeback.
• Interpretation: Traders often interpret the Inverted Hammer as a potential signal for trend reversal, or at least a consolidation phase after a downtrend (and a confirmation by a follow-up bullish candle such as a green candle the next day adds strength to the signal).

What does a Double Inverted Hammer Candlestick Pattern signify?

A Double Inverted Hammer pattern occurs when two consecutive Inverted Hammers form on the chart, typically in the context of a downtrend, and this pattern can be a stronger reversal signal compared to a single Inverted Hammer. 

The first Inverted Hammer signals a potential shift in sentiment, while the second one reinforces the idea that the downtrend is losing momentum.

The success rate of a Double Inverted Hammer pattern is higher than that of a single Inverted Hammer, especially if both candles are accompanied by strong volume and appear near key support levels. 

Backtesting results and studies (such as those by Thomas Bulkowski in Encyclopedia of Chart Patterns) suggest that the Double Inverted Hammer can have a success rate of around 70% to 80% when confirmed by subsequent bullish price action.

When does the Inverted Hammer Pattern Appear?

The Inverted Hammer pattern typically appears after a downtrend or a prolonged period of bearish movement, signaling that the market could be poised for a reversal. 

It tends to form after a sharp decline or a series of bearish candles, suggesting that sellers may be losing momentum and that buyers are beginning to regain control.

It’s important to look for the pattern near support levels or price floors, as these areas are where a reversal is more likely to occur.

How to Trade the Inverted Hammer Candlestick Pattern

Incorporating the inverted hammer pattern into your trading strategy usually involves the following steps:

1. Find the Right Inside Bar Setup (typically on key resistance)

Before you can use the Inverted Hammer effectively, it’s vital to first identify the right setup.

• Look for a definite downtrend: The Inverted Hammer should form after a sustained downtrend－the larger the preceding bearish move, the more significant the potential reversal.
• Identify key support or resistance zones: Inverted hammers are particularly powerful when they occur near significant support levels (they can also be used near key resistance points if you’re in an uptrend).
• Inside bar formation: Sometimes, the Inverted Hammer can form after a bullish inside bar or consolidation period, and, in this case, the breakout following the inverted hammer could give a clear signal for a reversal.

If you notice that the price has been declining and the candlestick pattern forms near a previous support level or trendline, this is a potential signal that the price could reverse upward.

2. Wait for the appearance of the Inverted Hammer

Once the right setup is identified, wait for the inverted hammer to appear－the candlestick itself should:

• Indicate a reversal: The long upper shadow signals that buyers are starting to push prices higher.
• Form after a bearish move: The pattern is most significant when it appears after a downtrend or bearish candle, suggesting that buying pressure is coming in after the selling pressure.

This gives you the signal that a possible shift in market sentiment could be underway－don’t, however, enter the trade immediately after the inverted hammer.

Wait for confirmation from subsequent price action－you’ll corroborate the signal with other indicators, and wait for a strong initial move upwards before placing your trade.

3. Choose your trading Take Profit (the goal of the setup)

After spotting the inverted hammer and confirming it with other indicators (like the RSI, MACD, and/or volume analysis), it’s time to plan your take profit:

• Support/resistance levels: The take profit can be set at the next support or resistance level, depending on whether you’re anticipating a bullish or bearish move.
• Risk-to-reward ratio: Aim for a risk-to-reward ratio of at least 1:2 or better (this means for every dollar you risk, you want to target two or more dollars in profit).
• Previous swing high/low: Another strategy is to place the take profit at a previous swing high (if buying) or swing low (if selling).

4. Open your Trade – Entry Point/Stop-loss/Position Size

Once you have your target and confirmation, enter your trade:

• Entry point: The entry point is typically at the close of the inverted hammer or once the price breaks above the high of the inverted hammer.
• Stop-loss: Set a stop loss just below the low of the inverted hammer (this helps to minimize your risk in case the price does not follow through on the reversal).
• Position size: Ensure you use appropriate position sizing based on your risk tolerance (a good rule of thumb is to allocate no more than 2% of your account balance when trading this pattern).

If the inverted hammer has a long upper shadow and a small body, place your stop-loss just below the low of the candlestick.

This allows for larger room for the trade to develop, but also protects you from substantial losses if the pattern fails.

What are the Pros and Cons of Trading the Inverted Hammer Pattern?

We have listed all the advantages and disadvantages of this candlestick pattern below:

Pros of the Inverted Hammer

The Inverted Hammer signals a potential shift in trend direction, which could be highly profitable if identified correctly. The pattern can be used on various timeframes, and is applicable in different market conditions. The Inverted Hammer provides clear signals for entering and exiting trades, which makes it easier to implement a disciplined trading strategy.

Cons of the Inverted Hammer

The inverted hammer alone is not enough to confirm a trade－you need to wait for further price action or other indicators to validate the signal. Like any candlestick pattern, there is a risk of false signals (the market can sometimes reject the Inverted Hammer, leading to losses). The inverted hammer is more reliable in specific market conditions, such as after a strong downtrend or at a clear support level.

What is the Hit Rate of the Inverted Hammer Candlestick Pattern?

On average, the pattern has a success rate of around 54-70%, but this can vary significantly based on the context in which it appears.

A study by Thomas Bulkowski (author of The Encyclopedia of Candlestick Charts) indicates that the Inverted Hammer has a success rate of around 50% when used as a reversal signal, meaning that it has a 50% chance of indicating a bullish reversal when it appears after a downtrend.

Bulkowski also suggested that the Inverted Hammer performs better when confirmed by subsequent price action, such as a close above the high of the candlestick.

Furthermore, a paper by S. C. Liu and J. Y. Chen (2004) entitled “A Study of the Candlestick Pattern for Stock Price Prediction” concluded that candlestick patterns, including the Inverted Hammer, can have varying degrees of predictive power, depending on how they’re integrated into broader technical analysis methods. 

You can improve the hit rate by:

• Using additional confirmation tools like the RSI, MACD, or volume.
• Trading the pattern only in strong trends or at key support/resistance levels.

Can the Inverted Hammer Pattern’s signal fail?

Yes, like all technical analysis tools, the inverted hammer pattern can and does fail. Failed signals are typically seen when the price reverses in the opposite direction after the pattern appears.

Common reasons for failure include:

• Weak market sentiment: If the broader market trend is too strong (a solid and persistent downtrend), the inverted hammer might not result in a reversal.
• Lack of confirmation: Without additional confirmation from other technical indicators or price action, the inverted hammer may not be reliable.

You should always use proper risk management strategies and avoid entering trades based solely on this pattern－ideally multiple confirming indicators will denote a genuine setup.

Possible Strategies for the Inverted Hammer Pattern

To improve the effectiveness of the inverted hammer pattern, you can combine it with other strategies:

• Support/resistance breakout: Use the inverted hammer in conjunction with a breakout strategy (if the pattern forms near a support level, wait for the price to break above the high of the candlestick to confirm the reversal).
• Trendline break: Combine the inverted hammer with trendline analysis (if the pattern forms at a trendline, and the price breaks above it, this is a strong confirmation signal).
• Candlestick confirmation: Look for a follow-up bullish candlestick after the inverted hammer, as this will help to confirm the reversal.

Alternatives to the Inverted Hammer Pattern

Below you will find some Alterantives to the Inverted Hammer:

Inverted Hammer vs. Hammer Candlestick Pattern

The inverted hammer and the hammer candlestick are often confused, but they have distinct differences:

• Inverted Hammer: Appears after a downtrend and signals a potential bullish reversal (the long upper wick indicates that buyers are starting to gain control).
• Hammer: Appears after an uptrend and signals a potential bearish reversal (it has a long lower wick, indicating that sellers have attempted to push prices lower).

Both patterns have similar shapes, but are used in opposite contexts (the Inverted Hammer is used for potential bullish reversals, while the Hammer is used for bearish reversals).

Inverted Hammer vs. Shooting Star Pattern

Both the Inverted Hammer and Shooting Star share a similar visual appearance (a small body at the bottom, a long upper shadow, and little to no lower shadow), however, they occur in different contexts and signify opposite market behavior:

The Inverted Hammer appears in a downtrend and is a bullish reversal signal－it indicates that despite initial selling pressure, the bulls managed to push the price higher during the session.

The Shooting Star, on the other hand, appears in an uptrend and is a bearish reversal signal－it shows that, despite initial buying pressure, the bears pushed the price back down, signaling that the uptrend may be coming to an end.

The key difference between the two then is that an Inverted Hammer signals potential bullish reversal after a downtrend, while the Shooting Star signals a potential bearish reversal after an uptrend.

What are the Limitations of the Inverted Hammer Pattern?

While the Inverted Hammer is definitely a useful pattern, there are several limitations to be aware of:

• False signals: The Inverted Hammer can often provide false signals if it appears in the middle of an existing uptrend or after an extended sideways move－in these cases, the market may simply be consolidating, and the reversal might not occur.
• Confirmation required: The Inverted Hammer is not a standalone indicator－it requires confirmation from subsequent price action, such as a bullish follow-up candle or a breakout above resistance, as without this confirmation, the pattern could just be part of a larger consolidation.
• Lack of volume: Volume plays a crucial role in confirming the validity of the pattern (without increased volume during the formation of the Inverted Hammer, the reversal signal may be weaker).

Learn Pattern Trading with WR Trading Mentoring

Learning how to trade candlestick patterns effectively requires time and practice. One great way to accelerate your learning is through mentorship, and WR Trading Mentoring offers personalized coaching, strategies, and tips to help you master candlestick pattern trading.

Conclusion: A Profitable Candlestick Pattern when Confirmed

The inverted hammer candlestick pattern has long been a powerful tool for identifying potential reversals in the market. When used correctly (with proper confirmation and risk management strategies), the Inverted Hammer can give you profitable trades.

By understanding its structure, recognizing the right trading setups, and combining it with other analysis tools, you can greatly improve your chances of success in the markets. As with any pattern, your willingness to practice, as well as patience and discipline are key to maximizing your success rate with the Inverted Hammer.

Frequently Asked Questions on Inverted Hammer Candlestick Patterns: