Inverted Hammer Breakout

Entry Logic

• Exact entry trigger: Buy on a break above the high of the Inverted Hammer candle.
• Confirmation requirements: The Inverted Hammer must appear after a downtrend. The upper wick should be at least twice the body length. Volume should increase on the breakout candle.
• Timeframe required: 15-minute or 60-minute chart.
• Location context: The pattern should form near a potential support level or after a significant price decline.
• Market condition requirement: A market showing signs of bottoming or attempting to reverse a short-term downtrend.

Exit Logic

• Profit target(s): First target at the 50% retracement of the preceding downtrend. Second target at the start of the downtrend.
• Scaling out rules: Exit 50% of the position at the first profit target.
• Trailing stop rules: Use a parabolic SAR as a trailing stop.
• Exit on signal failure: If the price fails to break the high of the Inverted Hammer and instead breaks the low, the setup is invalid.
• Exit on opposite signal: A strong bearish candle formation negates the signal.
• Exit on time expiration: If no upward momentum develops within 3-5 candles, close the position.
• Exit on momentum loss: Declining volume on subsequent up candles indicates waning interest.

Stop Loss Structure

• Hard stop location: Place the stop loss below the low of the Inverted Hammer candle.
• Soft stop rules: N/A.
• Maximum dollar loss per trade: Limit risk to 1% of account equity.
• Maximum percent loss per trade: The stop loss distance should not exceed 1.5% of the instrument's price.
• Structural stop placement: The stop is placed below the recent swing low.

Risk Management Framework

• Risk per trade: 0.75% of capital.
• Maximum daily loss limit: 2.5%.
• Maximum weekly loss limit: 6%.
• Maximum drawdown allowed: 20%.
• Risk-reward ratio requirement: Seek setups with at least a 1:2.5 risk-to-reward ratio.

Position Sizing Model

• Recommended sizing approach: Volatility-based position sizing.
• Volatility-based adjustment: Use the 14-period ATR to calculate the position size.
• Conviction-based sizing (A+/A/B setup): A+ for patterns at major long-term support. A for patterns at minor support. B for patterns mid-range.
• Scaling in rules: Add to the position on a successful retest of the breakout level.
• Scaling out rules: Scale out at predefined resistance levels.

Trade Filtering

• Market conditions to avoid: Strongly trending down markets without any signs of deceleration.
• Specific setups required: A clear Inverted Hammer after a defined down-move.
• Stock/instrument requirements: Stocks that are responsive to technical patterns.
• Time of day restrictions: Avoid entries during illiquid market hours.
• Chop/news avoidance rules: Check the economic calendar for high-impact news.

Context Framework

• Trend direction assessment: The higher timeframe may still be down, but the intermediate trend should be showing signs of basing.
• VWAP relationship: Entry is often below VWAP, with the goal of price crossing above it.
• Moving average relationship: The pattern can form near a flattening or curling 20 EMA.
• Range location: Typically occurs in the lower area of a trading range or after a breakdown.
• Higher timeframe alignment: A bullish divergence on the RSI or MACD on the higher timeframe adds confirmation.

Trade Management Rules

• When to move stop to breakeven: After price has moved 1.5R in favor of the trade.
• When to scale out: At key Fibonacci levels or previous structure.
• When to add size: On a successful pullback and hold of the breakout zone.
• How to handle fast moves vs slow moves: Let fast moves run to the next major resistance. Manage slow moves with a tighter trailing stop.

Time Rules

• Optimal trading window: Mid-morning (10:00 AM - 11:00 AM EST) after initial volatility subsides.
• Times to avoid: Opening and closing prints.
• Session-specific notes: Can be effective in any session but requires sufficient volume.

Setup Classification

• A+ setup criteria: Inverted Hammer at a multi-year support level with significant volume and bullish divergence.
• A setup criteria: Pattern at a daily support level with increasing volume.
• B setup criteria: Pattern with a less-than-ideal shape or at a minor support level.
• C setup criteria (avoid): Pattern appearing in a strong, accelerating downtrend.

Market Selection Criteria

• Instrument requirements: Mid to large-cap stocks, major currency pairs.
• Volume/liquidity requirements: Average daily volume over 500,000 shares.
• Volatility requirements: Avoid instruments with extremely low or high ATR values.

Statistical Edge Metrics

• Expected win rate: 50-55%
• Average win size: 2.5R
• Average loss size: 1R
• Profit factor: 1.3 - 1.6
• Expectancy per trade: At least 0.3R.

Failure Conditions

• Market conditions where strategy fails: A persistent, strong downtrend where every rally is sold.
• Specific scenarios to avoid: Chasing the breakout if it gaps up significantly.

Psychological Rules

• Key mental discipline requirements: Must be willing to buy when the market looks weak. Requires patience to wait for the breakout confirmation.

Advanced Components

• Market regime detection: Use a trend-identifying indicator like the Aroon indicator to gauge trend strength.
• Volatility/liquidity filters: Trade instruments with a spread of less than 0.1% of the price.
• Correlation filters: N/A.
• Multi-timeframe alignment: Confirmation from a higher timeframe is critical for this reversal strategy.

Location

• Where this setup is strongest: After a capitulation-type move where volume spikes and the price is far from its moving averages.
• Where this setup is weakest: When it forms in the middle of a trading range with no clear preceding trend.
• Location changes outcome: Its location after a downtrend is the most critical factor for success.