Inverted Hammer Explained & Backtested (2024)

The inverted hammer candlestick pattern is a one-bar bullish reversal Japanese candlestick pattern that leads to short-term volatility in all markets backtested.

If you’re following traditional inverted hammer candlestick strategies, you’re likely losing money if you’re using the standard entry.

Keep reading if you want to learn how to trade the inverted hammer and smash the competition like a dwarven king using the best inverted hammer trading strategies, according to history.

What Is an Inverted Hammer Candlestick Pattern?

The inverted hammer candlestick pattern is a one-bar bullish reversal pattern.

The inverted hammer gets its name from looking like an inverted hammer on a candlestick chart.

The pattern leads to bullish action, but the entry and exit are critical. But before we learn the best inverted hammer trading strategy, let’s learn how to identify this one-bar pattern.

How to Identify the Inverted Hammer Candlestick Pattern

The following are the requirements for a valid inverted hammer candlestick pattern:

• A small real body with little to no lower wick and a long upper shadow at least three times the size of the body.
• The inverted hammer must occur during a downtrend.

We see the inverted hammer on the Microsoft (MSFT) October 11th, 2021, daily chart.

The pattern’s last and only candle closes under the fifty-day simple moving average, giving us a bearish trend. We see a small-bodied green candle with a tiny wick and a long upper shadow, fulfilling the inverted hammer pattern requirements.

Now that we know how to identify these two-bar patterns, how do we best trade this supposed bearish continuation?

How to Trade Inverted Hammer Candlestick Patterns

The inverted hammer candlestick pattern should be traded using a bullish reversal strategy in all markets using a modified entry, according to a 21-year backtest. 

Let’s learn how traders typically lose money when trading this pattern, and then I’ll show you how professional, data-driven traders execute this setup.

Inverted Hammer Bearish Reversal Trade Setup

Let’s practice identifying the inverted hammer pattern.

We see that that price action is hovering around the simple moving average. Price is in a downtrend as the inverted hammer’s close is below the fifty-day SMA. We see a small green candle with a tiny lower shadow and a long upper wick, giving us the upside-down hammer pattern.

With the inverted hammer identified, traditional traders go long at a break of the high and set a stop loss below the low.

Unfortunately, this setup has a negative edge, and traders will lose money using this trading strategy.

Data-driven traders understand this, and they go long at a break of the close with a stop loss below the low.

Let’s hammer this into our brains using the daily chart of Nvidia on March 27th, 2020. The inverted hammer closes at $63.18. Price gaps up the next day and opens at $63.84, trigging an entry.

This data-driven trader made substantial profits.

Speaking of profits, what does history tell us about the best inverted hammer trading strategy?

Does the Inverted Hammer Candlestick Pattern Work? (Backtest Results)

Using the following rules, I backtested the inverted hammer candlestick pattern on the daily timeframe in the crypto, forex, and stock markets.

• A close above the 50-day SMA constitutes an uptrend.
• I tested risk-reward ranges from 1 to 5. 
• The optimal risk-reward ratio is selected using profit per bar.
• Entry and exits are discussed in the how-to trade section above.
• Confirmation must occur within three days of the pattern signal.

Similar Candlestick Patterns

Multiple candlestick patterns are often confused with the inverted hammer pattern. It’s essential to understand the differences when using candlestick pattern technical analysis.

Hammer Candlestick vs. Inverted Hammer

The hammer candlestick pattern is a one-bar bullish reversal pattern. The only difference between the hammer candlestick pattern and the inverted hammer is that the wicks are reversed.

The hammer has little to no upper wick and a long lower wick, whereas the inverted hammer has little to no lower shadow and a long upper shadow. 

Shooting Star vs. Inverted Hammer

The shooting star candlestick pattern is a one-bar bearish reversal pattern with a long upper wick and little to no lower shadow. The prevailing trend is the only difference between the shooting star and the inverted hammer. The shooting star occurs in an uptrend and is a bearish reversal, whereas the inverted hammer occurs in a downtrend and is a bullish reversal.

The Bottom Line

The inverted hammer is a frequently occurring one-bar bullish reversal pattern that is best traded as intended utilizing the close for an entry in all markets according to a 21-year backtest. 

The pattern is supposed to suggest bullish action, but it means volatility ahead, according to the data. If you’re looking to go bull, check out the backtest data for the best breakout candlestick patterns.