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6.21.13 Friday

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Hammer Candle Stick Intro

We all know and heard of candle stick called Hammer.  It is the candle that has long lower wick (2-3+ times it’s body) with small body at the top.  And it is a early reversal signaling candle in a downtrend stock or indices but what many do not not understand is that the location of Hammer is actually more important than the formation hammer itself or the size for that matter.  So through this comprehensive analysis, I want to present to you different type of Hammer candle and ascertain which one has power like Thor’s hammer to completely reverse the trend and which one is just a Bob the Builder’s hammer that you can play around with for few days.

I want to also say this as a disclaimer that nothing is 100% in the stock market and anything can and will happen but I am speaking in terms of probabilities and chances of playing out in a certain direction when you pay attention to these details.

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Trend Reversing Hammer Candle

Rule is pretty simple as it states in this sub topic title, “Trend Reversing”, the downtrend has to be progressed and established trading way below 50EMA for the downtrend to be reversed via Hammer candle.  If the Hammer appears too early right after breaking down at the top of it’s bullish trending move, many times, its just a resting pattern that sometimes resulted in dead-cat-bounce type of action.

So let’s look at some $SPY daily chart examples.

[March 2011 $SPY Daily Chart with 50EMA]

As you can see about 3 Hammer candle appeared (highlighted red) after breaking down near 50EMA but it never was a “trend reversing” candle but more of bearish continuation or pausing initiative.  But when the Hammer candle appears (highlighted yellow) at the bottom of it’s trend well below 50EMA, it became a “trend reversing” Hammer candle

[March 2003 $SPY Daily Chart with 50EMA]

It took two tries but as you can see after well below 50EMA and with few months of progressed downtrend, Hammer candle became that “trend reversing” candle.

[March 2009 $SPY Daily Chart with 50EMA]

This one is not a Hammer candle but rather it’s Doji or long legged Spinning Top but the sentiment would’ve been exactly the same had been the Hammer candle showed up right at that spot. Actually the sentiment would’v been so much stronger with Hammer candle then Doji or Spinning Top.  But the story is same here. Well below 50EMA and several months of drawn out bearish downtrend, Doji or Hammer appears, trend reverses.  Again Hammer is a “trend reversing” candle so the bearish trend must be somewhat established and trading well below 50EMA.

[July 2010 $SPY Daily Chart with 50EMA]

Same rules apply here. Hammer candle appeared after several months of downtrend well below 50EMA then the trend reversed.  Again “trend reversing” candle is the Hammer.  Not bumps, rests or short-term bounces for few days. That’s now what Hammer candle does.

[November 2012 $SPY Daily Chart with 50EMA]

You got the idea.

So now let’s look at the Hammer candle that is more suited for Bob the Builder and to be his Golden Hammer!!!

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Hammer Candle that’s Best Suited for Bob

(Technically these Hammers should not even be labeled or categorized as Hammer candle)

These Hammers tend to appear after long drawn out bullish trending stocks or indices and when the uptrend is starting to fall off from the top of it’s move after 2-3 days of severe bearish move.  So you will see them very near to 50EMA, many times below 50EMA but not far.  These Hammers are the ones that usually give lot of problems to amateurs or uninformed players who assume that this is a “trend reversing” hammer candle.  But more than not, they are simply Bob the Builder’s hammer that carries little or no potency.

These Hammer candles are not “trend reversing” candles but rather they are a bearish continuation candle or possible short-term bounce before it’s establishment of bearish trend.  So let’s look at some charts and see what I am talking about.

[July 2007 $SPY Daily Chart with 50EMA]

So after several months of bullish trend, $SPY started to find some strong resistance and rolling over. As you can see after just several days of downside move, Hammer appeared right at 50EMA.  This is where many would expect the bullish run to continue because of that Hammer candle but what they are not understanding is Hammer is “trend reversing” candle so when the trend is technically in a uptrend, there is nothing to reverse to. So it just became a rest stop for bears.

[2007 November $SPY Daily Chart with 50EMA]

Here you can see few Hammer candles here. The first one had few days of bounce but it was not a “trend reversing” effect and the second hammer became just part of this downtrend to continue next few more days.

[May 2012 $SPY Daily Chart with 50EMA]

Hammer appeared but again it became a resting point and this thing tanked hard next day.

[May 2012 $SPY Daily Chart with 50EMA]

You are getting the idea.

[October 2012 $SPY Daily Chart with 50EMA]

This Hammer appeared right at 50EMA where this triple top was forming back in October of 2012.  As you can see, next day it gaped down traded sideways for about two weeks and $SPY broke down.  Technically when the Hammer showed up, it was still in bullish trend because that triple top was never confirmed.  So it was not a Hammer candle.

[November 2012 $AAPL Daily Chart with 50EMA]

You are looking at $AAPL daily chart here and I am sure many of you remember back in middle of October of 2012 when, conspicuously, many were calling out that this Hammer is going to be a “trend reversing” candle. Well we did have short-term bounce for about 2 days or so but then the trend continued to the downside thus it just became a resting/passing point before the bearish trend starts to really establish and sped up.

What you really need to note here is that 50EMA was near and it never closed above 50EMA and it tanked.

So let’s look at today’s Hammer candle

[Today $SPY Daily Chart with 50EMA]

So here the Hammer near 50EMA, who’s Hammer is this one? Thor’s or Bob’s?

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$SPX: S&P 500 Index May 2012