The inverted hammer is a type of candlestick pattern found after a downtrend and is usually taken to be a trend-reversal signal. The inverted hammer looks like an upside down version of the hammer candlestick pattern.
It is a reversal candlestick pattern with long upper shadow and no lower wick. It is a simple candlestick pattern made of a single candleline. They are bullish in nature and appear at the end of a down trend. It has its name because of its resemblance to the hammer which is placed upside down. It may also mean that the market is getting ready to hammer the prices from below up.
The pattern is made up of a candle with a small lower body and a long upper wick which is at least two times as large as the short lower body. The body of the candle should be at the low end of the trading range and there should be little or no lower wick in the candle.The long upper wick of the candlestick pattern indicates that the buyers drove prices up at some point during the period in which the candle was formed, but encountered selling pressure which drove prices back down to close near to where they opened. When encountering an inverted hammer, traders often check for a higher open and close on the next period to validate it as a bullish signal.
Formation of Inverted Hammer Pattern
A Hammer candlestick which is inverted typically appear at the end of a down trend. They have a small real body at the lower end of the candle. The body may be red or green. They have a long upper wick which is double the height of the real body. The lower wick may be absent or very short.
It is formed because of the bulls not allowing the bears to push the price down. The stock is in a down trend and at a crucial support level. After opening, the buyers push the prices up by creating demand. Intraday traders who are also in the mood of bullishness, add to the demand.
But later in that time period the sellers increase in number thinking that the prices have pulled back due to a correction in a down trend and the supply for the stock increases. As it reaches a crucial level level the bulls accumulate stocks using this selling frenzy.
Any amount of selling is neutralized by equally increased buying at the lower level. As the demand increases more than the supply the price stops falling further and closes near the opening, either just below or just above the opening price. This results in a small body and a long upper shadow, which is double the height of the real body, with no or a very small lower shadow, which looks like a Inverted Hammer.