This post will outline the characteristics of spike patterns, aka shooting star (bearish) and hammer pattern (bullish). We will also look at how to distinguish between high and average probability setups. Specifically, we’ll look at how to trade spike patterns together with key support resistance levels. The pattern is an effective tool for identifying reversals and is part of our new tool, the Auction Bars indicator.
Characteristics of Spike Patterns
First of all, a spike bar is made up of a small body with a long shadow. Therefore, they’re easy to identify on charts and a lot of traders will pull the trigger when they see this pattern. Why? Because, as the old norse saying goes; “A spike that sticks out is very likely to get hit by a hammer.”
Bullish vs. Bearish Spike Bar / Shooting Star vs. Hammer Pattern
Basically, a spike bar tells us that prices were rejected at at certain level, and that the market pushed back to where the candle opened. If a shooting star or hammer pattern occurs at the end of a move, we can assume that momentum is out of steam, and that it could reverse.
Although easy to spot visually, we need to define the requirements for being a spike bar. In addition to having a small body and long shadow, the hammer pattern should:
- have a body which is at one end of the range, not in the middle
- have a significant range (average or above average)
- plot a significant volume (average or above average)
- mark a higher high / lower low than the last of N bars
Below is a good example of a bullish spike bar / hammer pattern (blue). The shadow is much larger than the body, which is small and closing at the upper end of the range. Furthermore, we see that this bar has just made a new low, compared to the previous bars.
Bullish Spike / Hammer Pattern without higher timeframe range levels
Trading Spike Bars
The difference between high and average probability spikes will depend on the characteristics listed above. A spike bar that closes at one extreme end of its range, has a higher probability of being profitable than one closing in the middle.
Next, we’ll want to establish whether the market is trending or is ranging. Knowing this will help us understand what’s going on with the market and how to position ourselves. Spike Bars that form with the trend have a higher probability of being profitable. However, we will also look for potential setups in ranging markets and at trend reversals.
In the chart below, the horizontal lines show us a higher timeframe trading range (the high and low points during the last 60 minutes). This is what we call the auction range. The idea is that the market is ranging 80% of the time, and then, suddenly there‘ll be a breakout, with a close outside the range.
Bullish Spike / Hammer Pattern at Range Low – Bearish Spike / Shooting Star at Range High
As can be seen here, a bullish spike bar / hammer pattern formed at the lower end of the higher timeframe range and then, the market broke out of this range, creating a new 60 minutes range above the previous one. A bearish spike / shooting star then other formed at the upper area of the range and the market retraced back towards the mid range.
Spike Bars at Key Support Resistance
In the next chart we see a bullish spike bar / hammer pattern at daily floor pivot level. The pivot range is green because yesterday’s regular session closed next to the daily high level. The spike bar forming at the daily main pivot, indicates that lower prices are being rejected. This may indicate a trend continuation of yesterday’s bullish move.
Bullish Spike / Hammer Pattern at the Main Pivot
As seen above, we’ll want to trade spike bars in areas of key support resistance levels. Other than session pivots and higher timeframe range levels, we can also use the volume weighted average price (VWAP) as a benchmark.
Bullish Spike / Hammer Pattern at Daily VWAP
Session pivots, higher timeframe ranges and VWAP levels are all objective price benchmarks that work as meeting points between buyers and sellers. Identifying spike setups at these levels will improve your odds. This is because market participants are likely to “respect” these objective and well established price benchmarks.
As we’ve seen, spike patterns are easy to spot. By adding pivot, VWAP and higher timeframe ranges, we ensure that other uncorrelated market conditions support the setup. The more conditions point in our favor, the better our odds will be.
Bullish Spike / Hammer Patterns vs. Bearish Spike / Shooting Star
Trade entry and stop loss
The relation between our entry and the stop-loss determines the risk we’ll take on the trade. This needs to be accepted and well understood before entering the trade. The entry for spike bars will typically be a sell- or buy stop order just above/below of where the body is located. The stop loss is placed right above or below the candle’s shadow.
Conclusion
To sum it all up, spike bars are useful for locating favorable trade setups. It is a reliable signal, when used together with higher timeframe ranges and key support resistance levels. Ideally, we want to see a spike bars plot at the outer end of a higher timeframe range, or at pivot and VWAP support resistance levels. This is where different traders‘ belief systems line up, giving us high probability setups.
Our next post will be on reversal bars. This setup is similar to spike bars in that it signals rejection of price at a specific level. These are both high probability setups and compatible with the pivot, VWAP and other key support resistance levels that you may already use.
To read more about our premium suite follow this link. For additional trading resources, you may review our Indicator Library for NinjaTrader 8 at LizardIndicators.com.