A Trade A Day

Hammers are candlesticks formed when, during a decline in price, the stock opens, heads lower during the session and then rallies at the end. What you have essentially is a small body at the upper part of the trading range and a long tail. The pattern looks like a hammer, hence the name. There are a few definitions of hammers out there. An acceptable definition can be found at stockchart’s candlestick pattern dictionary

But I’m not here to lecture on the ideal hammer formation. I want to talk about how to trade them. Like most of the strategies I employ, trading a hammer requires three important elements:

1. Prior Price Expansion
Simply put, I want the last two or three bars preceding the hammer to be big marubozu or marubozu like. The bigger the better. The reason is simply that I want sellers to exhaust themselves.

2. Current Volume Confirmation
Volume equals conviction. A hammer is equal to buyers overcoming sellers to finish the session well off the lows of the day. Higher volume on a hammer says that ultimately, buyers were able to win the session. This is significant when the stock has been declining for several trading days.

3. Subsequent Price Confirmation
Since Hammers are seen as reversal patterns, I need to see that the market has indeed reversed. Once a hammer occurs, one of the next couple of sessions should see price move above the high of the hammer and stay there. I can make a couple of entries, but my two most common are 1. Enter the stock over the high of the hammer (my stop is bottom of the hammer’s trading range or 2. Wait for a confirmation day and a retracement back to a moving average (smaller stop, more shares, less risk, and typically a better trade). Number two is my typical hammer play. Nothing too complicated in the entries, but simple seems to work well.

One other element I failed to mention. Trade hammers that occur in areas of support. This may seem obvious, but traders don’t always do it. In any trade, you want to put as many elements of the trade as you can in your favor.

Need a chart?

If you like this post, then consider subscribing to my full feed RSS feed. You can also Subscribe to A Trade A Day by Email and have new posts sent directly to your inbox.

6 Comments »