What is Hammer Formation?

Definition and Meaning of Hammer Formation

The hammer pattern is a candlestick formation that expert analysts interpret as an indicator of the potential upcoming rise of a financial asset. The hammer pattern is considered one of the most reliable indicators on a candlestick chart, especially when it occurs in an area of ​​recognized price support for a security after a prolonged downtrend.

What Does the Hammer Formation Look Like? 

The color of the candle is not important in the hammer formation. There are 3 basic recognition criteria.

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• The long shadow is about two or three times larger than the actual size.
• There is little or no upper shadow.
• The actual body is at the upper end of the range.

History and Usage Areas of Hammer Formation

The hammer pattern is a part of Japanese candlestick analysis, hence it emerged as a component of candlestick analysis. It is known that it was first developed by rice traders in Japan in the 1700s. In some studies, Japanese trader Homma Munehisa is considered the first figure of the concept of candlestick analysis. 

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Homma Munehisa (1724–1803) was a legendary Japanese rice merchant from Sakata and is considered one of the pioneers of technical analysis. Homma was one of the people who understood that the market is influenced by emotions such as fear and greed as well as supply and demand. He commented on market behavior in his famous work Sakata Senho (Sakata Rules). Patterns derived from his teachings, such as Doji and Hammer, have become standard tools in technical analysis. Homma's extraordinary success in business earned him great wealth and samurai status. 

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In the 20th century, technical analysis methods became popular in the Western world and Japanese candlesticks were included in the analysis methods. Steve Nison's Japanese Candlestick Charting Techniques, published in 1991, was the book that made Japanese candlesticks well known globally.

Hammer Formation Types: Bullish and Bearish

Bull hammers and bear hammers are two key components of technical analysis used to visualize price movements in financial markets. These represent opposing market sentiments, such as optimism and pessimism, respectively, and help investors identify trends and potential returns.

Bullish Hammer Formations 

A bullish candlestick occurs when the closing price of an asset is higher than its opening price over a certain period of time. This indicates that buyers are dominant and the price is moving upwards. Bullish candlesticks are usually represented in green or white and are associated with rising market momentum. Patterns such as bullish engulfment and hammer are common bullish formations. For example, a hammer with its small body and long lower wick signals a potential recovery after a downtrend.

Bearish Hammer Formations

A bearish candlestick forms when the closing price is lower than the opening price, signaling that the sellers are in control. These candlesticks are usually shown in red or black and reflect downward market momentum. Bear formations such as bearish engulfing and shooting star are critical signals. For example, a shooting star has a small body and a long upper wick, indicating a possible reversal following an uptrend.

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Hammer Formation and Technical Indicators

Using the hammer pattern together with technical indicators such as RSI and MACD makes it more possible to predict market movements.

Hammer Formation and RSI (Relative Strength Index)

The hammer formation becomes important and oversold conditions may be observed when Relative Strength Index (RSI) values ​​are below 30. This alignment indicates that the market may be poised to reverse as selling momentum fades. Differences between price action and RSI can further strengthen the signal. For example, if the hammer forms at a new price low while the RSI is trending upward, the potential for an uptrend becomes stronger.

Hammer Formation and MACD (Moving Average Convergence Divergence)

Moving Average Convergence Divergence (MACD) gives an idea about momentum and trend direction. When the hammer coincides with a narrowing MACD histogram or the intersection of the MACD line above the signal line, the possibility of an ascending uptrend becomes stronger. If the crossover occurs near a key support level where the hammer forms, it becomes even stronger. However, attention should be paid to the MACD continuing its downward trend despite its hammer appearance. Because the decline may not be over yet.

Hammer Formation Examples in Markets

The hammer formation can be frequently observed in different segments of financial markets (cryptocurrency, stocks, forex). 

Hammer Formation Examples in the Cryptocurrency Market

Bitcoin (BTC) Example – March 2020 Crash (COVID-19 Crash) 

Bitcoin experienced a serious decline in March 2020 and fell to $3,800. During this period, a hammer formation formed on the daily charts and then the price recovered to $10,000 levels.

Hammer Formation Examples in the Stock Market

Turkish Airlines (THYAO) Example - COVID-19 Period (March 2020)  

In March 2020, Turkish Airlines shares fell sharply due to the COVID-19 pandemic. The price dropped to 8 TL. During this period, a hammer formation with a long lower shadow formed on the daily charts. After the formation, the stock started to recover. The price exceeded 10 TL levels in a short time.

Aselsan (ASELS) Example - Recovery After 2022 Decline  

Aselsan shares reached an important support point at 25 TL in 2022. At this point, a hammer formation formed and signaled the end of the decline. After the hammer formation, the share price started to rise rapidly and tested the 30 TL level. The long lower shadow indicated that buyers were strongly engaged.

Hammer Formation Examples in the Forex Market

EUR/USD Example - Decline in 2017

The EUR/USD parity formed a hammer formation at the 1.0500 level in 2017. After this formation, the parity started to rise and reached 1.2000 levels. 

GBP/USD Example - Post-Brexit Drop

After the Brexit vote, GBP/USD parity fell sharply. Hammer formation was observed at 1.2000 levels. This formation was the first sign that the parity would recover to 1.4000 levels.

Other Hammer Formations

Inverted Hammer Formation 

The inverted hammer candlestick pattern has a small body and a long upper shadow. It usually appears at the bottom of a downtrend and is considered a distinct signal of a potential uptrend reversal. The bullish signal becomes even stronger if the inverted hammer pattern forms near a significant support level.

Engulfing Bull Formation

The bullish engulfing formation consists of two candlesticks - a bearish candle and a bullish candle. It usually occurs at the end of a downtrend. The last bearish candlestick is completely swallowed by a larger bullish candlestick. A bullish engulfing formation occurs at the end of a downtrend as selling pressure weakens and buying pressure strengthens.

Bear Engulfing Formation

The engulfing bear formation, as its name suggests, emphasizes the downward trend. It consists of two candles - the first candle is green and the second candle is red. The red candle is larger than the previous candle (green candle). That is, the body of the red candle is larger than the body of the green candle. There is also a difference between both the opening and closing values ​​of the two candles. It should be underlined that the bearish engulfing formation occurs at the top of the uptrend.  

Doji Formation

Doji Pattern refers to a chart formation consisting of a single candle. It occurs when the opening and closing prices of a candle are almost the same. It manifests itself with a small-bodied candle whose upper and lower wicks resemble a plus sign. There are different variations of Doji patterns with unique names such as Long-Legged Doji, Gravestone Doji, Dragonfly Doji, and Doji star candlestick pattern. All Doji patterns provide traders with four critical data points: the open, close, high price, and low price for a given period.

Advantages and Disadvantages of Hammer Formation

• It is easy to define. Hammer formation can be easily noticed in the graphic thanks to its long drop shadow and short body structure. It quickly offers potential reversal signals. 
• It may show the possibility of return. Hammer formation usually indicates that a downtrend may end and an uptrend may begin. It helps identify buying opportunities, especially at support levels.
• It simplifies risk management. The lowest point of the lower shadow can be used as a stop loss level. This allows creating a clear risk management strategy. 
• It is suitable for use in different markets. Hammer formation can be considered an effective analysis tool in many markets, from stocks to commodities, from currency pairs to cryptocurrencies.

• It may not be enough alone. Hammer formation does not always offer a return guarantee. Misleading signals may occur, so it is important to support it with other analysis methods. 
• There is a risk of timing error. Buying immediately after seeing the formation may be risky. Additional signals or candlesticks should be examined to confirm accuracy. 
• Varies depending on market context. Hammer formation mostly becomes meaningful at the bottom points of the trend. However, it can give misleading results when it occurs in horizontally moving or uncertain markets. 
• It is more effective over longer time frames: Reliability may decrease as it may occur frequently over short time periods. Analyzing on daily or weekly charts can provide more accurate results.

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