Using the bearish inverted hammer in your trades

To provide you with a winning scenario for the bearish inverted hammer (Figure 8-11), I offer a pattern that actually came up while I was searching for an example for this section. This chart is for the Financial Select Sector Fund, symbol XLF, which is an ETF that represents a handful of large financial stocks such as Citigroup, American International Group, and Bank of America. You can see the bearish inverted hammer near the top of the chart. When I saw the pattern, I figured I should put my money where my mouth is. I knew that even if the trade didn't work out, I'd still have an example of a failing pattern for later in this section. Luckily, though, that wasn't the case.

Figure 8-10:

The bearish inverted hammer.

Figure 8-11:

A bearish inverted hammer that works on a chart of the XLF ETF.

Figure 8-11:

A bearish inverted hammer that works on a chart of the XLF ETF.

I shorted the XLF on the signal day of the pattern, held it for four days, and exited on the first up day. I also placed a buy stop order at the open of the signal (or hammer) day. That's a very tight stop, but this trade was outside of my normal trading activity, and I felt it was prudent to place a close stop. More aggressive traders may have chosen the high of the signal day for their stop.

The example in Figure 8-11 is doubly useful because it also shows you how to exit a trade. I don't discuss exiting trades much in this book — too many methods and goals exist once a trade has been initiated to cover here — but

Figure 8-12:

Two bearish inverted hammer failures on a chart of the DIA ETF.

this situation is definitely worth pointing out. I chose my exit in this trade because the reciprocal version of the bearish inverted pattern appeared. I saw the bullish pattern, and I was happy to exit and take a profit of just over a dollar on one hundred shares — I'll let you do the math — and take my wife to dinner on the proceeds. I ended up with material for this book and a nice dinner for Merribeth. Now that's a perfect trade.

Recognizing a losing trade

On a somewhat gloomier note, have a look at Figure 8-12 for an example of a couple of failing bearish inverted hammers. Figure 8-12 is a chart of the ETF that represents the 30 stocks that comprise the Dow Jones Industrial Average and trade with the symbol DIA, sometimes called the Diamonds. Luckily for this author and trader, there wasn't a real-life trade involved with this example.

Both patterns appear in an uptrend, and both feature an up setup day followed by a gap opening and strong activity during the signal day that reverses with a lower close. Although usually an indication of a reversal, both times these signals were proven to be false fairly quickly.

In the case of the first pattern, all possible resistance levels were violated and the uptrend continued. For the second pattern, I highlight two failures:

I One is a violation of the open of the hammer day. I The other is a violation of that day's high.

Figure 8-12:

Two bearish inverted hammer failures on a chart of the DIA ETF.

The second pattern takes a little longer to fail, but it does eventually. The second pattern is interesting because it does occur toward the end of the uptrend. But the signal is violated, and a trader following the rules would have exited the short. This additional illustration shows how you sometimes have to just follow the rules and move on, even when it's clear later that you could've turned a profit if you'd stuck with the position. Don't look back and say "what if?" Be confident in the fact that you followed set rules and that over the long haul, following the rules results in more consistent trading profits.

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