5 Rules For Trading A Reversal Hammer

There is a school of thought that a trader should focus on one or two “bread and butter” type set-ups and get as good as they can at them.  It’s something that I used to read about on Trader X and the Wall Street Warrior’s blogs, and I have come to totally agree with.

I have found one of the more reliable intra-day setups is to buy off of a reversal hammer, however there are a few rules I follow in order to raise the percentages is my favor.

1.  There has to be an “aggressive” downtrend preceding the hammer; in fact the more violent and bloody the better.

2.  You want to see a large volume and price spike on the candle before the hammer.  This is key because it usually means that the last group of longs are “throwing in the towel” en masse.

3.  The hammer has to reverse in/at a previous support level.

4.  The hammer has to be green, and the closer to a hammer opposed to a doji the better.

5.  The overall market direction should be up, flat, or slightly down.  Trying to catch a reversal hammer when the broad market is down big on the day is a losing game.

This chart on $AAPL illustrates an almost a perfect reversal hammer set up.  The only negative is that the actual body of the hammer is not as big as I would like it to be.

Some traders think that you should wait for an inside consolidation bar after the hammer before you buy the break, but I don’t agree.  The dynamics of a hammer reversal, with the spike down on volume and price, as well as the long tail of the hammer itself, should mean that all sellers are exhausted, at least temporarily, and price should move back up fairly strongly.

A consolidation bar tells me that buyers are not easily overpowering sellers, and that the hammer may just be a temporary pause before a new round of sellers come in.

Once you have bought the break of the hammer’s high, if you are a conservative trader, you should take a partial when price touches the 9 EMA.  If you are an aggressive trader, you could take a position based upon 50-75% of the hammer’s length instead of the total length, and also take a partial at the 9 EMA.

The most conservative way to play a hammer reversal is to not buy the break of the hammer, wait for price to bounce, settle back down to the support area, and form a second hammer.  You could then buy the break of that hammer.

Why not subscribe to bclund.com for free  Via E-mail or Via RSS and follow me on StockTwits and Twitter?

What bclund is, is the intersection of markets, trading, and life (with some punk rock, pop culture, and off-beat humor mixed in).

Brilliant stuff like this rains down like..well, rain, on my stream during the week. If you want to get wet, follow me on Twitter and StockTwits. You can also pick up my book Trading – The Best of the Best: Top Trading Tips For Our Times by clicking here.

17 Responses

  1. Hi Brian .
    Do you take care or not about the catalyst that creates the sell off ?
    ( bad earnings report, new public offering, negative result in a new drug test , FDA not approval, directors changes, fraud investigations , bankrupcy rumors, etc etc )

    thanks in advance

  2. Pingback: Top Trading Tips For Our Times Webinar with Brian Lund | Trading True

  3. Pingback: How To Pick Up Your Money In The Market Today | The bclund BlogThe bclund Blog

  4. Pingback: The Trade In $AAPL For Monday - bclundbclund

  5. Pingback: Trading The Morning Star Reversal Setup - bclundbclund

  6. The best execution trigger for the setup you described (in addition to the ones you mentioned) are what I call the setup bar / entry technique.

    Entering on the hammer close opens you up to the risk that you get additional downside if the whole thing turns out to be a bust.

    See example in the SPY a year ago

    One way to greatly reduce this risk is to wait for the hammer (which is now the setup bar, not the entry bar) to officially close, then enter on the next bar at the first tick above the setup bar’s high. This ensures that if the setup’s hypothesis is correct “…that all sellers are exhausted, at least temporarily, and price should move back up fairly strongly” you’ll be in, but if not, you don’t preempt the situation and get stuck in an example like the above.

    If intraday, say on a 5min chart, you’d have to wait for the 5 min increment where the hammer occurred to complete, then enter if triggered on the next bar.

    Here is an intraday upside example

  7. Pingback: 5 Rules For Trading A Reversal Hammer courtesy of Brian Lund | FXTraderPauls Trading Adventures

    • Because it relies on the intensity of the “volume/price” spike as an important factor, it don’t think that translates as well the more macro you get.

      Thanks for reading.

    • I have no ability to program so I don’t know the answer to that, but I am sure someone out there could figure it out. For me it is always just observation. I know what stocks I will be looking at the night before, so if that behavior is happening with one of them I will usually see it.

      Thanks for reading Jack.

  8. This is a good setup, I’ve seen it happen a lot. Usually I am on the side selling at the point when all the sellers are exhausted though. To be clear, you are just day trading this stock, taking on the position at the reversal and selling before the end of the day? Or using it as a method to take on a long position? Sometimes I use intraday charts to TRY and time my entry points on a trade I plan to hold longer term.

    • That’s how we find set ups Alex. We see our pain point enough times and then think, “hey maybe I want to be on the other side of that pain.”….lol. Believe me, I took me a long time to figure that out.

      As for the example, I am just using it for a day trade, although if the overall market conditions were right, you could use it to initiate a swing.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>