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Inverted Hammer Pattern Signals Trend Change at Trader’s Narrative

I pointed out the clear hammer candlestick that appeared in myriad charts yesterday as the market rebounded from its intra-day low to close higher for the day. Today’s inverted hammer candlestick is also very important to notice. Perhaps even more so in light of the recent downtrend and the previous hammer.

According to traditional Japanese candlestick interpretation, when an inverted hammer candlestick appears after a significant downtrend (like now) it signals the end of the downtrend and an imminent trend change. An inverted hammer may seem to be a strange pattern upon which to hang expectations for a bounce higher. After all, isn’t it the opposite of a hammer? doesn’t it indicate that the bears pushed back the bulls from the intra-day high? Yes, and no.

inverted hammer SPX May 2010

An inverted hammer by the way looks exactly like a “shooting star” the only difference is that the latter is printed subsequent to an uptrend while the former arrives after a downtrend. You can think of it this way: the bears are starting to cover their short positions, pushing prices higher. But this new higher price is met with a relief by longs with weak hands who are happy to receive a good opportunity to exit.

Since there is no guarantee with this pattern (or any other Japanese candlestick pattern) it is important is to watch for confirmation. When, or if, price closes above the body of the inverted hammer, then we have even stronger indication of a trend change. By the way, this is the same congestion level at 1080 I mentioned yesterday I wanted to see cleared.

Dow Breadth
The other point I wanted to cover is a familiar measure of breadth for the Dow. Because there are only 30 stocks in the Dow Jones, the percentage of them trading above their moving average tends to be “chunky”. However, just like the measure for the S&P 500 index (which is smooth thanks to 500 constituents), this indicator is pointing to an extremely oversold market right now since there are zero Dow components above their 50 day moving average. The last time this was similarly oversold was back in March 2009.

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9 Responses to “Inverted Hammer Pattern Signals Trend Change”  

  1. 1 tee1

    We are the Borg. Lower your shields and surrender your ships. We will add your biological and technological distinctiveness to our own. Your culture will adapt to service us. Resistance is futile.

  2. 2 Steve

    Shorts are starting to cover?

    What shorts?

    Shorts have been burned since March 2009

    Market has been manipulated by a PPT and HFT for approximately one year.

    Shorts have learned not to short this market.

    So again, what shorts?

    Constant rise on no volume is not a good environment for shorts

    An inverted hammer with a close near the bottom of the candle is a different animal from an inverted candle with a close half way up the body.

    Opinions make the horserace

  3. 3 Makemyday

    Thank u 4 ur concise, intelligent and thoughtful posts. I like to read ur blog coz I feel I get straightfoward explanations that are right on the money. Best of all, I always learn something new. Keep it coming!! Thanks.

  4. 4 AB

    Certainly the pattern looks like a dead cat bounce after the “flash crash”.

  5. 5 BM

    This “inverted hammer” can also be seen as a Larry Williams “smash day”: a close above the upper wick of the candle means game on for the bulls for a short while…

  6. 6 Investor

    The first inverted hammer you flag is white though, yesterday’s was black. Doesn’t that difference matter?

  7. 7 WimpyInvestor

    Today is the critical day. SPY close above open would finally confirm the intermediate-term bottom. Close above SPY $110 would be even more bullish.

    Rapidly dropping VIX and rising 10-year T-Bill yield suggests that the worse is over (in terms of panic selling and “de-risking” of all risk-assets by the weaker hedge funds).

    Other great indicators to confirm resumption of risk-trade are: Oil and Euro/Yen both up; JNK and HYG both up (high yield credit spreads tightening); and EEM / FXI / EWZ / EWC all up to confirm global growth / secular bull market in emerging markets / commodities.

  8. 8 Peter

    Thank you very much for your great call and excellent work!

  9. 9 spencerfrater1

    A white inverted hammer and a black inverted hammer… hmmm… one of these is not to be trusted… you choose which. Note the common support level at around 1060. Closes significantly below this next week will see panic in the Street. Maybe Prechter is about to have his day in the sun again. OMG we’ll never hear the last of it.
    Spend it whilst you still have it - is that rampant roar and thrill of mad thrust bettered by increasing (?) numbers on a piece of paper?
    Friday evening - yee hah

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