The Hanging Man candlestick pattern is characterized by a short wick (or no wick) on top of small body (the candlestick), with a long shadow underneath. If the candlestick is green or white, the asset closed higher than it opened. If it is red or black, it closed lower than it opened.
Candlestick pattern traders believe the Hanging Man is a bearish reversal indicator.
Key Takeaways
- The Hanging Man is a type of candlestickpattern that refers to the candle's shape and appearance and represents a potential reversal in an uptrend.
- Candlesticks display a security's high, low, opening,and closing prices for a specific time frame and reflect the impact of investors'emotions on prices.
- The Hanging Man occurs when two criteria are present: an asset has been in an uptrend, and the candle has a small body and a long lower shadow.
Understanding the Hanging Man Pattern
The Hanging Man is a single candle stick pattern. Because it is a reversal pattern, there must be a trend of some length before the appearance of the pattern. The market doesn't need to be in a long uptrend, but there must be a recognizable price rise preceding the pattern.
Four points are used to form a candlestick—the high, opening, closing, and low prices. The wick on top represents the high price, and the candle's body is formed using the open and close prices. The shadow is formed by the low price for the period.
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Psychology of the Hanging Man Pattern
It's important to understand what's going on that makes the pattern form. At all times, there is a battle unfolding between bulls (those who believe prices are going to rise) and bears (those who think prices are going to fall).
Price charts are used to interpret this unending battle. Candlesticks provide a highly vivid interpretation of price patterns. By looking at a particular candlestick pattern, the trader can get an immediate visual clue as to who controls the market.
The Hanging Man comes after a price advance, so it is bearish because it shows that the price had been advancing over successive days, with the bulls firmly in control. But on the day the Hanging Man formed, the bulls were initially in control but lost it.
During the session, the bears began to push the price down—so far down that a daily low formed far from the open. The bulls came back in and pushed the price up. This battle continued until closing, at which time opening and closing were close to the high, and the low for the day was well below the body.
Because the opening and closing prices are close, the body is small. The body of the Hanging Man can be black (or red) or white (or green), but it must be small. The Hanging Man will have a long shadow that is two or three times the length of the body.
The low and the high of the candle (in our case, trading day) is at extreme ends of the price range during the trading day. There may or may not be a wick. If there is a wick, it will be small.
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Interpreting the Hanging Man Pattern
Thomas Bulkowski'sEncyclopedia of Candlestick Charts suggests that the longer the shadow, the more meaningful the pattern. Using historical market data, he studied some 20,000 Hanging Man shapes. In most cases, those with elongated shadows outperformed those with shorter ones.
Bulkowski's researchalso supports the theory that strong trading volume accompanying the Hanging Man leads to more successful trades. Of the many candlesticks he analyzed, those with heavier trading volume were better predictors of the price moving lower than those with lower volume.
Another distinguishing featureis the presence of a confirmation candle the day after a Hanging Man appears. Since the Hanging Man hints at a price drop, the signal should be confirmed by a price drop the next day. That may come by way of a gap loweror the price moving down the next day. According to Bulkowski, such occurrences foreshadow a further pricing reversal up to 70% of the time.
The chart below shows two Hanging Man patterns for Meta (META) stock, both of which led to at least short-term moves lower in the price. The long-term direction of the asset was unaffected, supporting the belief that Hanging Man patterns are only useful for gauging short-term momentum and price changes.
The long shadow means sellers stepped in aggressively at some point during the formation of that candle, causing the open, close, and high prices to be well above the low.
Spinning Tops
The Hanging Man is a type of candle known as a spinning top. These are candles with small bodies. The size of the shadows is not important in the formation of the spinning top; the small size of the body is what matters.
The size of the shadows varies and can range from none to a similar size on top and bottom. They may even appear as elongated shadows. Spinning tops also form components of other candle stick patterns, such as the Morning Star and Evening Star.
It's worth noting that the color of the Hanging Man's body isn't of concern. All that matters is that the body is relatively small compared with the lower shadow.
Trading the Hanging Man Pattern
The Hanging Man patterns that have above-average volume, long shadows,and are followed by a selling day have the best chance of resulting in the price moving lower. Therefore, it follows that these are ideal patterns to use as a basis for trading.
Upon seeing such a pattern, consider initiating a short trade near the close of the down day following the Hanging Man. A more aggressive strategy is to take a trade near the closing price of the Hanging Man or near the open of the next candle.Place a stop-loss order above the high of the Hanging Man candle. The following chart shows the possible entries, as well as the stop-loss location.
:max_bytes(150000):strip_icc()/hanging_man_trade_strategy-5bfd934f46e0fb00518666ed "Hanging Man Candlestick Pattern Explained (3)")
Limitations of the Hanging Man Pattern
One of the problems with candlesticks is that they don't provide price targets. Therefore, stay in the trade while the downward momentum remains intact, but get out when the price starts to rise again. Hanging Man patterns are only short-term reversal signals.
If you're on the lookout for anyHanging Man, the patternis only a mild predictor of a reversal. Look for specific characteristics, and you'll find it becomes a much better predictor.
However, there are things to look for that increasethe chances of the price falling after a Hanging Man. These include above-average volume, longer shadows,and selling the following day. By looking for Hanging Man candlestick patterns with all these characteristics, it becomes a better predictor of the price moving lower.
Even though traders often count on candlestick formations to detect the movement of individual stocks, it is also appropriate to look for candlestick patterns in indexes, such as the or Dow Jones Industrial Average. Candlesticks can also be used to monitor momentum and price action in other asset classes, including currencies orfutures.
Hanging Man vs. Shooting Star vs. Hammer
There are two othersimilar candlestick patterns, which can lead to some confusion for new traders.
The Hanging Man appears near the top of an uptrend, and so do Shooting Stars. The difference is that the small body of a Hanging Man is near the top of the candlestick, and it has a long shadow.
A Shooting Star has a small body near the bottom of the candlestick, with a long wick. A Shooting Star is a Hanging Man flipped upside down.In both cases, the shadows should be at least two times the height of the body. Both indicate a potential slide lower in price.
TheHanging Manand theHammerare both candlestick patterns that indicate trend reversals. The only difference between the two is the nature of the trend in which they appear. If the pattern appears in a chart with an upward trend indicating a bearish reversal, it is called the Hanging Man. If it appears in a downward trend indicating a bullish reversal, it is a Hammer. Apart from this key difference, the patterns and their components are identical.
Is a Hanging Man Pattern Bullish or Bearish?
The Hanging Man pattern is a bearish reversal indicator that appears at the end of an upward trend.
How Accurate Is the Hanging Man Pattern?
Some traders believe it is a reliable indicator; many think it is a poor indicator. It's possible that accuracy lies in how each trader uses it with the other available information.
What Is the Difference Between the Hanging Man and Hammer?
The formation is nearly identical, but the Hammer forms when a downtrend is about to reverse. The Hanging Man forms when an upward trend is about to reverse.
The Bottom Line
The Hanging Man occurs frequently. If you highlight them all on a chart, you will find that most are poor predictors of a price move lower. Look for increased volume, a sell-off the next day,and longer shadows—the pattern becomes more reliable. Don't forget to utilize a stop loss above the Hanging Man high if you are going to trade it.
