Euro vs Dollar Weekly Candle Chart - 2nd February 2009

The weekly candle for last week has provided an interesting signal with an inverted hammer, following the four down bars from the reversal  early in January. An inverted hammer is often the first sign that a trend has reached a reversal point, and as with any candle we will need to see next week’s candle for bullish verification. The intuitive response to an inverted hammer is that prices have risen in the period, only to fall back later, suggesting weakness in the move and a move lower, which is why it is vital we wait for any bullish signal to confirm the candle. So the question is ‘ why should  the apparently “negative price action” seen in the inverted hammer, provide us with a bullish signal?’ The answer lies in what happens in the next session, in this case next week. If next week’s candle opens and closes over the body of the hammer, then it means that those traders who shorted at the opening or closing of the inverted hammer are losing money. The longer the market holds above the body of the inverted hammer then the more likely that these short positions will cover, adding to the weight of those picking bottom turning points.

The inverted hammer can be a tricky signal to interpret, as it seem to fly in the face of logic, but it often provides suprises and we need to be careful in our analysis, and wait for the confirming bullish signal. If this does not arrive next week, then we can discount the signal in the medium term.

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