Here is a simple intraday trading setup based on the Candlestick pattern. The chart timeframe for this intraday candlestick pattern strategy is 5 minutes.
Interestingly, you can use this setup to trade stocks, equity indices, commodities or even currencies. Further, you can use any instrument to trade it i.e. cash (equity shares), futures or options. Also, with this strategy you can trade in a bullish as well as a bearish market.
The candlestick pattern that we are going to trade is a Hammer candlestick pattern. Hammer pattern is a bullish reversal pattern. The key is to spot a hammer pattern in specific zones or areas to take best advantage of the movement that can follow post a hammer.
Let’s understand the step by step process as to how we analyze and trade this strategy. This is an Intraday buy Strategy. You will buy first and then sell later to square off your position.
Steps of the setup:
We’re analysing the Nifty spot chart in the example below.
Step 1 : Identify a hammer pattern after a downtrend.
There are two ways to identify a hammer.
- It should have a small upper wick, small body and a long lower wick.
- It shouldn't have an upper wick, but it should have a small body and a long lower wick.
Both of them can be qualified as hammers. Let me show you a classic hammer pattern after a downtrend with a help of an image below
You can see the hammer circled in red. Here, it doesn’t have an upper wick/shadowand has a small body (thick square shaped body) and a pretty long lower wick/shadow. That is a textbook hammer pattern.
Also we can see, the hammer is after a downtrend.It is important to spot a hammer after a clear downtrend and not after an uptrend or a sideways (consolidating) trend.
You may have a question looking at the hammer thinking if we need to see a red hammer or a green hammer. Like I mentioned above, since hammer is a bullish reversal pattern, we have to look for a green hammer pattern. Green candle also indicates there are more buyers than the sellers and gives that extra confidence to trade.
Step 2 : Spot a hammer near it’s previous support zone.
Like I mentioned above. It is very important to look for a hammer pattern at specific zones. In our strategy our specific zone is a support zone. A support zone is a zone where the price makes a low and bounces back upwards from that low. You may also call it a swing low wherein the price is in a downtrend, it pauses at a certain zone or it halts at a certain zone and moves upwards. The zone from which it made a low and bounced back is called the support zone or the swing low zone.
We will look at a price chart on Upstox pro web platform to understand step 2 in detail.
We can see the PURPLE line drawn at 16410.87 is our support zone or the swing low zone because the price bounced back from this zone previously. After a gap up, the price tumbled down and formed a hammer pattern exactly near our previous support zone of 16410.87 which we may see a trend reversal from bearish to bullish. Japanese candlesticks are such a beautiful gift to mankind!
Now that we know how to spot a hammer and where to spot a hammer, let’s see how we can trade the same.
Step 3 : Let's understand with the help of a chart as to what price do we enter, where do we keep our stop loss and when do we exit (target)
You can see the GREEN line (16431) that's where we got the confirmation of the hammer pattern at the support zone. The moment the hammer high is broken, our entry is triggered. We will enter at around those levels at 16431. Since Nifty spot can’t be traded, you can look to trade Nifty futures or options. If you choose to trade options, one way to go about it is that you can buy an ATM (at the money) strike price call option to trade. The market price is 16431 in our example and the nearest strike price seems to be 16450 call options. Since it’s an intraday day, you can go for weekly expiry rather than a monthly expiry contract.
Coming to stop loss now. You can see the RED line (16396) which is the low of the hammer. That's 35 points below the entry point of 16431. If the Nifty goes down and hits 16431 (our stop loss) we will take a loss and exit from our position.
Since it’s an intraday trade and a Nifty trade, the timeframe being 5 minutes, we will aim for a risk to reward of 1:1. In our example the risk being 35 points, we will aim for a target of 35 points too from our entry price which comes to 16466 (16431+35 )
You can see the PURPLE line (16466). Once our price hits 16466, we will exit our 16450 call option position and come out with our profit.
We hope this simple hammer pattern strategy was simple and easy to understand. You can try spotting it on charts and see if you are able to identify such setups.
What is important here is the zone where you spot the candlestick patterns! We don’t have to randomly see a hammer anywhere in the chart.
We’ll be coming with a lot of strategies on candlestick patterns which will help to identify trade setups easily.
Happy Trading until then!