It occurs at the end of a downtrend, and it's one of the candlestick patterns technical analysts look for.
The validity of the candlestick depends on three factors:
- A long shadow/tail
- A volume spike
- Preferably a bounce off of a standard moving average like 20/50/200.
Even if you don't believe in technical analysis this pattern makes intuitive sense. At the hammer, short sellers and panic sellers are exhausted which means the people that wanted to sell have sold already. Meanwhile, value investors and technical investors notice and start buying, driving the price up. That's what creates the tail. The shorters that sold short earlier will cover (i.e. buy) to lock in profits. In addition, the people that got stopped out or missed the low will chase the stock, sending it even higher.
In the past, whenever I saw a stock on my watch list tank 10-15%, I would immediately buy it thinking it's a really good deal, however, it just continued to fall. I know this is cliche, but DON'T catch a falling knife. Do some research to make sure there's nothing fundamentally wrong. Have a little patience and wait for the hammer.
-The Hawk
How to trade the hammer:
Other candlestick patterns:
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