Put This Hammer In Your Trading Toolbox!
The Dynamic Wealth Report
January 7, 2010
by Justin Bennett, Editor
Growing up on a ranch gave me a lot of great experiences. Most of these
experiences involved hard work and early mornings.
“Get out of bed, we’re going fencing!” Dad said, interrupting my last
minute of early morning sleep. Dragging myself out of bed and grabbing
a bite to eat, I headed out into the open range.
Most of my early summers as a teenager revolved around swinging a
hammer. I walked miles of seemingly never ending fence, fixing breaks in
the barb wire and pounding nails. Yes, the basic tool used for
centuries, the hammer, was my summer companion.
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The hammer, strange as it may sound, is a useful trading tool as well.
Hammers are a type of candlestick bar that can give you a low risk
setup…
Let me show you what I mean…
This chart of
Transocean (RIG) shows a great example of how to use a
hammer. RIG is a leader in the offshore drilling industry with a market
cap of over $29 billion.
Take a look at the bar marked “Hammer”. A hammer is formed when the
price goes
to a new low on the day. During the same trading day, the
price will reverse upwards and
close above the open of the day. Looking
at the chart, you can see this is exactly what happened in RIG.
Now here’s the key to using hammers effectively…
Hammers are
only useful when they happen after a short term downtrend. They must also coincide with a
technical support level. Also, seeing big
volume on the same day as the hammer is a great confirmation. The high
volume means lots of shares are trading hands around that price.
Now, if you look through as many charts as I do, you’ll notice hammers
occur quite often. Most of the time, hammers are
not an entry signal. If
they occur when a stock is trading sideways, or they don’t occur at a
support level,
they mean nothing. It’s just “noise”, don’t use it as an
entry signal.
I’ve also found that hammers are most effective in
highly liquid, higher
priced stocks. In my opinion, you should stay away from using hammers in
penny stocks.
But in the case of RIG, we had the necessary criteria for a trade…
The hammer formed after a downtrend. It was also at a support level (in
this case a test of the 200-day moving average). We got a nice high
volume day on the same day as the hammer.
You would enter this trade when RIG traded above the hammer on the
following day. In other words… for RIG, your entry would have been just
above
$68. You would set a stop loss below the hammer at around
$64.90.
Remember, you
always control your downside risk.
As you can see, RIG screamed to over $82. That’s a sweet
20% return on
your investment in 18 days.
As you may know, I like to put results into terms of reward to risk. For
this trade, your risk was $3.10 ($68-$64.90=$3.10) and your reward was
around $14 ($82-$68=$14). This gave you a reward to risk ratio of
around
4.5 to 1. That’s what I call a great trade…
So as you go through your charts every day, be on the lookout for these
trading opportunities. Just remember, you need the right kind of setup. The hammer must coincide with… a support level, high volume on the day,
and following a short-term downtrend.
Hammers can be a great low risk way to add profits to your portfolio!
***Editor's Note***
Just as an FYI, we're right in the middle of the launch of our new
trading service,
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park with these stocks lately...
One of the biggest winners in the ETF space has been SPDR S&P Metals and
Mining (XME). XME is up over 11% in the last four trading days. This ETF
is being driven by demand for mining stocks related to gold, silver,
coal, and copper.
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