The inverted hammer

An inverted hammer is a small body at the bottom of its range with a long upper shadow, after a fall. It resembles a shooting star, but the trend before it decides the name: after a fall, it is an inverted hammer; after a rise, it is a shooting star. The textbook demands a confirming candle before the turn is accepted.

What defines an inverted hammer

The inverted hammer is a single candle with a small body at the lower end of its range and a long upper shadow. The lower shadow is short or absent. The pattern appears after a fall, and it is read as a potential reversal: the long upper shadow shows that buyers pushed price up during the session, but sellers pushed it back down to close near the low. The small body and long upper shadow are the defining features.

The pattern is called an inverted hammer because it looks like a hammer turned upside down. The hammer has a small body at the top and a long lower shadow; the inverted hammer has a small body at the bottom and a long upper shadow. The inverted hammer is a bullish reversal pattern, but it needs confirmation.

The numbers behind the rule: rule IH-1 asks for a candle whose range is at least 1 ATR (the average true range of the last 14 sessions), whose body takes 5 to 35 percent of the range, whose upper shadow is at least twice the body and at least 60 percent of the range, and whose lower shadow is at most 10 percent of the range, after a fall: the close of the session before it stands at least 3 ATR below the highest close of the 10 sessions ending there. It counts as formed when the candle closes.

Why it resembles a shooting star

The shooting star is a candle with a small body at the lower end of its range and a long upper shadow, but it appears after a rise. The shape is the same: both candles have a small body near the low and a long upper shadow. The difference is the trend before the candle. After a fall, the same shape is called an inverted hammer; after a rise, it is called a shooting star.

The name depends on the context. The shape alone does not tell you which pattern it is; you must look at the candles before it. A shooting star is a bearish reversal signal, while an inverted hammer is a bullish reversal signal. The same shape means opposite things depending on where it appears.

Why the trend before it decides the name

The trend before the candle is the key. If price has been falling, a candle with a small body at the bottom and a long upper shadow is an inverted hammer, and it suggests that the fall may be running out of steam. If price has been rising, the same candle is a shooting star, and it suggests that the rise may be losing momentum.

The pattern is a description of what price did during the session: buyers pushed up, but sellers pushed back. The meaning is read against the trend: after a fall, the push up is seen as a sign that buyers are trying to take control; after a rise, the push up is seen as a sign that sellers are resisting. The trend decides the name and the meaning.

Why the textbook demands a confirming candle

The inverted hammer is a hint, not a verdict. The long upper shadow shows that buyers tried to push price up, but they failed to hold the gains. The pattern does not prove that a reversal has happened; it only suggests that one may be near. The textbook demands a confirming candle: a bullish candle that closes above the inverted hammer's high, or at least a strong bullish close in the next session.

Without confirmation, the inverted hammer may be just a pause in the fall. Price can continue to fall after an inverted hammer, and a trader who buys on the pattern alone may be caught. The confirming candle is the verdict: it shows that buyers have actually taken control.

What the chart under the heading shows

The chart under the heading is an inverted hammer on gold futures (GC=F), the candle of 15 March 2017. It opened at 1,198.20 dollars an ounce, reached a high of 1,221.20 and a low of 1,197.70, and closed at 1,200.10. The range is 23.50, the body 1.90, which is 8.1 percent of the range, the upper shadow 21.10 or 89.8 percent, and the lower shadow 0.50 or 2.1 percent, so it sits inside every limit of rule IH-1.

It is the cleanest by the rule's own measure of the four inverted hammers that rule found in ten years across three instruments: one on the Philippines fund, two on the PLDT ADR and one on gold futures. The chart shows the candle and the fall before it. It does not show whether a rise followed.

Patterns describe, they do not predict

An inverted hammer is a description of what price has already done: a candle with a small body at the bottom and a long upper shadow, after a fall. It is not a forecast of what price will do next. The pattern does not say that a reversal will happen, and it does not say how far the reversal will go. It only says that buyers tried to push up.

A reader who sees an inverted hammer on a chart should read it as a hint, not as a signal. The pattern is a useful way to see where buyers made an attempt, but the next move is not written in the pattern. The pattern describes; it does not predict.

What the count says

Rule IH-1 found four inverted hammers: one on the iShares MSCI Philippines fund, two on the PLDT ADR and one on gold futures. A body under 35 percent of the range, an upper shadow of at least 60 percent and almost no lower shadow, after a 3 ATR fall in 10 sessions, is a narrow shape, and four in a decade is what it produces on these series.

The count is not a base rate and it says nothing about whether a rise followed any of the four.

A failed inverted hammer often traps buyers who act too early

Many traders see the long upper shadow and assume the bulls have arrived. That assumption works only if the next candle confirms it. When confirmation does not come, price can drift sideways or fall further. The early buyer is then holding a position with no follow-through. The pattern described a push upward, but the push did not last.

The trap is worse after a sharp decline. A small bounce looks like an inverted hammer, and the long upper shadow seems to show selling pressure absorbed. But a single candle cannot absorb a week of selling. The next session often opens lower, and the bounce evaporates. The buyer is left hoping for a second attempt that may not come.

The practical consequence is to wait for the session after the inverted hammer to close. If that session closes above the inverted hammer's high, the pattern has some follow-through. If it closes below the open of the inverted hammer, the pattern failed. Acting before that close is a guess, not a reading of the pattern.

The inverted hammer is not a buy signal, but it can mark a place to watch

The pattern describes one session where buyers pushed price up and sellers pushed it back. That is all. It does not say the next session will rise. A trader who treats it as a buy signal is ignoring the fact that the session closed near its open. The close is the last piece of information the candle gives, and it shows no clear winner.

What the inverted hammer does is mark a level. The high of the candle is where buyers ran out of momentum. The low is where sellers failed to push further. Those two levels define a range. If price later breaks above the high with a strong close, the pattern has been confirmed. If price breaks below the low, the pattern has failed.