Page 62 - A Complete Guide to Volume Price Analysis: Read the book then read the market

A hammer is formed when in a session, the price has fallen, only to reverse and recover to close back near the opening price. This is a sign of
strength with the selling having been absorbed in sufficient strength for the buyers to overwhelm the sellers, allowing the market to recover. The
hammer is so called as it is 'hammering out a bottom', and just like the shooting star, is immensely powerful when combined with VPA.

Once again, the five principles outlined at the beginning of the chapter apply to the hammer candle, and again it is very easy to become over
excited as soon as you see this candle. It is so easy to jump into what we think is going to be a change in trend. If the market has been moving
lower fast, which they generally do, it is unlikely that a reversal will take effect immediately. What is far more likely, is that the market will pause,
mover higher, and then continue lower once again. In other words posting a short squeeze.

As we now know, the insiders have to clear inventory which has been sold in the move lower, and the first signal of a pause is the hammer, as the
insiders move in to buy, supporting the market temporarily. They may even push it higher with a shooting star candle. The hammer is signalling
'forced buying' by the insiders, and the shooting star is signalling 'forced selling' by the insiders. Whilst they do move bearish markets fast, there is
always selling that has to be absorbed at higher levels, and this inventory has to be cleared before moving lower once again. After all, if this did not
happen, the insiders would be left with a significant tranche of inventory bought at high prices, and not at wholesale prices.

A price waterfall will always pause, pull back higher, before continuing lower. As always, volume holds the key, and if the volumes have been rising
in the price waterfall lower, then this is a strong signal of further weakness to come. Therefore, a single hammer will simply not be enough to halt the
move lower, even if the volume is above average. As always, the price action that follows is key, as is the price and volume in the associated time
frames along with any price congestion in the vicinity. This is the same problem as before and the question that we always have to ask, whenever
we see a hammer or a shooting star, is whether the price action is signalling a pause in the longer term trend, or a true reversal in trend.

The power of the hammer candle, just like the shooting star, is revealed, once we see a sequence of two or three of these candles accompanied by
high or extremely high volume. It is at this point we know, for sure that we are in the realms of a buying climax and only have to be patient and wait
for the insiders to complete their task, before they begin to take the market higher.

Furthermore, we also have to remember that once the buying climax is completed, we are likely to see one or more tests using the hammer candle.
These candles may be less pronounced than the true hammer, perhaps with relatively shallow wicks, but the principle will be the same. The open
and close will be much the same, and there will always be a wick to the lower body.

For a successful test, the volume needs to be low too, and there is also likely to be more than one test in this phase. These tests can appea Csts
that onr both in the price congestion area of accumulation as well as in the initial phase of any breakout, as the price action moves back into an old
area of heavy selling immediately above.

These are the two candles which are our number one priority in reading of price and volume. As I'm sure you will recall from the introduction to
Volume Price Analysis, all we are looking for, on any candle or sequence of candles, is validation or anomaly. Is the volume validating the price
action and what signal is this sending to us, or is it an anomaly, and therefore sending us a very different signal.

In a sense, there is never an anomaly with a shooting star candle, since the price action is sending a clear message on it's own. As any price action
trader will tell you, this candle is a signal of weakness, in itself. There is no other interpretation. The market has risen and then fallen in the session,
therefore the market MUST be weak. What volume does is put this weakness into context, which is why I have shown the schematic with the three
volume bars, low, average and high (or even ultra high). A shooting star with low volume is a sign of weakness, but probably not significant, unless it
is a test of demand following a selling climax as we start the downwards move lower.

A shooting star with average volume is telling us there is weakness, it is a relatively strong signal, and the pull back may be more significant than in
the first example on low volume. Finally, we have the shooting star with high or ultra high volume and this is where the professional money is now
selling out. Whether it's the market makers in stocks and indices, or the big operators in futures, or the market makers in forex, or the big operators
in bonds, it doesn't matter. The insiders are selling out, and we need to prepare and take note, as a big move is on the way!

The point is this. There is never an anomaly with a shooting star, only ever a validation of the strength of the signal. The volume always confirms the
price action with a shooting star, and all we have to do is consider whether it is low, average or high to ultra high, and frame this in terms of the
preceding price action across our time frames, and track the subsequent candles as they unfold on the chart.

The same points apply to the hammer candle. Once again, there is NEVER an anomaly with a hammer candle. The price action tells us all we need
to know. In the session, for whatever reason, the price has moved lower and then recovered to close near or at the open. It is therefore a sign of
strength, and the volume bar then reveals the extent of this strength.

Once again, I have shown three hammer candles with three volume bars, low, average and ultra high as we can see in Fig 6.12.

A hammer with a low volume candle is indicating minor weakness, average volume suggests stronger signs of a possible reversal, whilst ultra high
signals the insiders buying heavily, as part of the buying climax. The volume is giving us clues on how far the market is likely to travel. An average
volume bar with a hammer candle, may well give us an intra day scalping opportunity. And there is nothing wrong with that. A low volume hammer is
simply telling us that any reversal is likely to be minor, as there is clearly little interest to the upside at this price level.