A Hammer is a candlestick with a small body (a small range from open to close), a long wick protruding below the body, and little to no wick above. In this respect it is very similar to a dragonfly doji.
The hammer appears at the bottom of a downtrend. In simple terms, the hammer’s long wick implies an unsuccessful effort by bears to push price down. Bulls stepped in and pushed the price back up quickly before the period closed. As such, a hammer candlestick, in the context of a downtrend, suggests the potential exhaustion of the bears and the possibility of a bullish reversal. On the next candlestick, price should pass the neckline, often determined by the high of the previous bar, in order to confirm the hammer’s reversal signal.
In advanced terms, the hammer can also represent stop hunting, or a run for stop orders.
The Hanging Man candle is identical in shape to the hammer with the difference that while hammers occur in a downtrend, the hanging man pattern occurs in an uptrend. The long wick protrudes below the body and suggests diminishing, bearish demand capable of pushing the price down. It is often a sign that the uptrend has run out of steam, giving bears the upper hand that leads to a reversal.
For the reversal signal to be confirmed, the consequent bearish bar should reach the neckline established by the open of the bullish bar on the other side of the hanging man.
The Inverted Hammer candle is a hammer candle turned on its head. It is a bullish candle with a small body and long upward wick and forms after a downtrend or at the bottom of a period of consolidation. The candle signals a possible reversal. An inverted hammer is also similar to the Shooting Star, which occurs during an uptrend instead.
Again, a reversal is confirmed with a bullish bar in the next period that should reach the neckline established by the open of the bearish bar on the left side of the inverted hammer.
This candlestick is simply the inversion of the hanging man. In simple terms, the shooting star occurs at the height of an uptrend and its long wick implies that resistance to further bullish movement has been encountered above the close, and a bearish reversal may be imminent. In this case, a strong bearish candle or a price at the level of the previous bar’s open can act as confirmation or a sell point.
In advanced terms, the shooting star can also represent stop hunting, or a run for stop orders.
The Bigger Picture
The color of any of these specific candlesticks, whether green or red, white or black, is of less importance! What matters most is that the body of these candlesticks is short and the long shadow at least twice as long as the body.
When a short-bodied candlestick with a long wick appears in the context of a trend, it often signals a potential reversal of that trend. A confirming candle is more than reassuring. That said, don’t get hang up on a literal interpretation of this or other guides.
Most important for a trader is to figure out what is is going on in terms of supply and demands, what is going on in the minds of participating bulls and bears, and how momentum is changing. Candlesticks, in confluence with other signals, can tell a very nuanced story.
Signals from these candlesticks and patterns are more relevant when they occur in territories of support or resistance set by moving averages or prior highs or lows, or overbought and oversold conditions set by indicators like RSI. Moreover, volume is not to be overlooked. Avoid buying into breakouts with low volume.
Hammer and hanging man candlestick patterns are similar to the gravestone and dragonfly dojis.