Candlestick patterns are essential for identifying potential price reversals and continuations in technical analysis. Today, we'll explore one of the most important patterns: the Hanging Man Candlestick Pattern.
Traders have all encountered the intriguing pattern that appears at the peak of an upward trend. Despite its ominous name, the "hanging man" candlestick pattern, part of Japanese reversal candlesticks, is crucial for identifying potential reversals. This pattern suggests that a downward move may be imminent, and that the asset may have reached local price highs.
Effective risk management necessitates a thorough understanding of the hanging man pattern. Recognizing this pattern allows traders to protect their investments and anticipate market changes. In this article, we will explore the formation, significance, and successful trading strategies of the hanging man candlestick pattern.
Hanging Man Candle - How to use this guide
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What is a Hanging Man Candlestick?
The "hanging man pattern" is a single-candle configuration that appears at the peak of an upward trend. Traders favor this pattern because it is considered a reliable indicator of potential shifts in trend direction.
The hanging man is recognized as a bearish candlestick pattern, signaling that bullish momentum may be waning and the market might soon reverse. It also suggests a significant sell-off occurred that day, which buyers could not overcome.
The "Hanging Man" candlestick pattern, a bearish reversal indicator in technical analysis, suggests a potential shift from an uptrend to a downtrend. This pattern features a small true body, a long lower shadow, and little to no upper shadow, typically forming near the peak of an uptrend.
It indicates a dramatic price drop during the day, with a close near the opening price, resulting in a small true body that resembles a hanging man, highlighted by the long lower shadow. The color of the body does not matter, it can be either red or green (bearish or bullish). An illustration of the pattern formation is shown below.
The appearance of the Hanging Man may not immediately signal the beginning of a reversal. Instead, it indicates that momentum might be waning, with price action preparing for a potential trend shift.
Traders use the Hanging Man pattern on the charts patterns to identify possible changes in market sentiment and guide their trading decisions. When this pattern emerges during a prolonged upswing, it suggests that bearish forces are gaining control, and buying pressure is decreasing.
How is Hanging Man Candlestick Formed?
A hanging man candle is characterized by a small real body, little to no upper shadow (wick), and a lower shadow that is at least twice as long as the body.
To identify the hanging man candle, consider the following factors:
- Upward trend: The hanging man is only discernible when it forms at the apex of an upward trend.
- Opening level: The hanging man candle can be either red (bearish) or green (bullish), but a falling market is best indicated by the bearish candle.
- Upper shadow: Prior to the notable decline in the value of the asset, a slight upper shadow suggests that an effort was made to continue the present upward trend.
- Long Lower Shadow: This is perhaps the most telling feature of the candle. It indicates a significant sell-off before the bulls attempted to regain ground, causing the closing price to end the session lower but still below the opening levels.
- Closing Level: The bearish hanging man candle is confirmed when the closing level is lower than the opening level.
Because the hanging man candlestick's long shadow indicates significant selling, it can be used to identify short trades and bearish market sentiments. The true test of the hanging man's validity often appears in subsequent chart activity. If the next candle continues to decline and breaks below the short-term upward trend line, it can be seen as a continuation of the long-term downtrend. Another potential entry point is entering the trade once the market falls below the hanging man candle's low.
Hanging Man vs. Shooting Star vs. Hammer
The hammer, shooting star, and hanging man candlestick patterns are renowned in technical analysis for their distinctive appearances and valuable insights into market dynamics. Despite their visual similarities, each pattern conveys a unique narrative about market behavior.
Both Shooting Stars and Hanging Men appear near the peak of an uptrend. The Hanging Man has a small body near the top of the candlestick and a long shadow, distinguishing it from the Shooting Star.
A shooting star features a long wick and a small body near the bottom of the candlestick. It is essentially an inverted Hanging Man. In both patterns, the shadows should be at least twice the length of the body, signaling a potential price decline.
Candlestick patterns indicating trend reversals include the Hammer Candle and the Hanging Man Candle. The key difference lies in the trend context: a Hammer appears in an uptrend, signaling a potential bearish reversal, whereas a Hanging Man appears in a downtrend, indicating a potential bullish reversal.
Understanding the underlying market psychology these patterns reflect is as crucial as recognizing their shapes. The shooting star, hammer, and hanging man provide crucial indications of upcoming shifts in market trends, emphasizing the importance of a comprehensive approach in technical analysis.
How to Trade Hanging Man Candlesticks
If you wish to trade after spotting Hanging Man pattern, you can use derivatives like CFDs. With derivatives, you can trade both rising and falling prices. Therefore, you can open a short position based on your prediction of the asset's price movement when Hanging Man pattern appears.
Follow these steps to trade Hanging Man pattern:
- Identify the pattern: To gauge market direction, examine the chart on a longer timeframe, such as a daily chart. Avoid trading against the prevailing long-term trend.
- Confirm the pattern: Use a shorter timeframe chart (e.g., 4 hours) to pinpoint the optimal entry point. A signal for a short trade is signaled by the formation of a hanging man candlestick.
- Execute your trade: Identify an entry point near the low of the hanging man candlestick. If your bearish market assessment proves correct, anticipate a subsequent price decline, validating your decision to initiate the short position.
- Manage risk: Align your trade size with your risk management strategy. Maintain discipline by adhering to the predetermined percentage of your total account risk per trade. Implement a stop loss at the highest point of the hanging man candle formation to mitigate potential losses.
Trading Strategies with Hanging Man Candlestick
Below we explore various Hanging Man candle strategies that can be applied to trading.
Trading Hanging Man pattern with Pivot Points
Pivot Point is a significant level chartist can use to determine directional movement and potential support/resistance levels. Pivot Points use the prior period's high, low, and close to estimate future support and resistance levels. In this regard, Pivot Points are predictive or leading technical indicators.
According to the chart above of the EUR/USD pair, we can observe the formation of the Hanging Man candlestick pattern after an upward trend reaching the pivot points line, which typically acts as resistance. As the price shows rejection at this level, you can enter a sell trade below the Hanging Man candle and set your stop loss and take profit levels, anticipating a move to the downside.
Trading Hanging Man Pattern With Fibonacci
Fibonacci retracement and extension levels offer unique support and resistance insights. Financial markets move in zigzag patterns, periodically retracing before testing new levels. The Fibonacci tool helps establish these retracement levels and projects extensions for potential price targets, useful for setting Take-Profit and Stop-Loss levels or counter-trend entries.
The GBP/NZD chart above shows a Hanging Man candlestick pattern that forms at a Fibonacci retracement level within a correction movement of a downtrend. With an uptrend, you can make a sell trade with the price breaking below the Hanging Man candlestick level while setting stop loss and take profit levels. Expecting a move towards the downside.
Trading Hanging Man pattern with RSI Divergences
The Relative Strength Index (RSI) is a technical indicator that traders could use to examine how the price is performing over a certain period. It is a momentum oscillator that measures the magnitude of price movements as well as the speed (velocity) of these movements. The RSI can be an extremely helpful tool depending on the trader's profile and their trading setup.
This strategy differs from other trading approaches. To identify a bearish RSI divergence, we first want to see the price in an uptrend, making higher highs and higher lows. The GBP/JPY chart above illustrates this, with the price making higher highs while the Relative Strength Index (RSI) makes lower highs, creating the desired divergence. When a Hanging Man candle appears at a higher price high and aligns with a lower RSI high, it generates a sell signal. With the price breaking below the Hanging Man candle level, a stop loss can be set at that level, expecting a move to the downside.
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Hanging Man Candlestick Pattern Pros and Cons
In trading analysis, the hanging man pattern serves as a valuable tool with distinct advantages and disadvantages. Understanding these aspects can empower traders to leverage their strengths while remaining mindful of its constraints.
Advantages
- Early Warning Signal: One of the primary advantages of the hanging man pattern is its ability to act as an early warning signal for potential trend reversals. When this pattern appears in a predominantly bullish market, it suggests an imminent shift towards bearish sentiment, allowing traders to prepare for a possible change in market direction.
- Easy Identification: The hanging man is easily recognizable due to its distinctive small body and long lower shadow. This simplicity makes it particularly valuable for traders new to technical analysis, facilitating the identification of significant market turning points.
- Enhanced Decision-Making: When combined with other technical analysis tools, the hanging man enhances decision-making processes. It encourages a comprehensive analysis of various market factors and indicators, leading to more informed and strategic trading decisions.
Disadvantages
- Confirmation Required: The hanging man pattern needs additional validation for reliable signals. Relying solely on it may not reliably indicate a bearish reversal without subsequent sessions confirming the signal, potentially delaying decisions. Integrating supplementary signals enhances its reliability with updated market insights.
- False Signals: Like any technical pattern, the hanging man is susceptible to generating false signals. It may appear in markets that continue to exhibit bullish trends, leading to erroneous bearish assumptions based on the pattern alone.
- Contextual Interpretation: The effectiveness of the hanging man pattern heavily depends on the surrounding market context and prevailing trends. Its interpretation can vary significantly when used independently or in highly volatile or sideways markets, making it a less dependable indicator under specific market conditions.
Final notes about Hanging Man Candlestick
The Hanging Man candlestick pattern frequently appears in charts, but not all instances effectively predict price declines. Look for longer shadows, subsequent selloffs, and increased volume to validate its reliability. When trading, always set a stop-loss above the Hanging Man's high.
In technical analysis, the Hanging Man signifies potential trend shifts amid uptrends. Its characteristics—a short body and extended lower shadow—signal early bearish tendencies. However, its true strength lies in combining this pattern with thorough market analysis and confirming it through subsequent price action.
To harness its potential, traders must adopt a comprehensive approach. Integrating the Hanging Man with other indicators and understanding broader market conditions enhances its effectiveness while reducing misinterpretation risks. Effective use requires meticulous risk management and deep market knowledge, allowing traders to adapt strategies to evolving market dynamics and respond adeptly to early reversal signals.
Free resources
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Sources:
- https://candlecharts.com/
- https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/technical-analysis
- https://www.cmegroup.com/education/courses/technical-analysis/chart-types-candlestick-line-bar.html