As a Forex trader looking for profit opportunities, you need to learn how to identify market reversal patterns. The hanging man is a clear example of a potential reversal that may occur at the top of an uptrend.
The hanging man is a bearish price formation that consists of a single candle with a small body and a long shadow. It sends a warning to the trader that an uptrend may be in its final stage and a reversal may take place soon. When combined with other technical analysis tools, the hanging man can provide enough insights to place a sell trade.
This candlestick pattern is commonly used by traders to assess the market sentiment and generate trading signals. In this blog post, we will take a look at the structure of this pattern, how to spot it. Moreover, you will learn how to make profitable trades using it.
Table of Contents
Characteristics of a Hanging Man Candlestick
Firstly, the candle should have its open (O), high (H), and close (C) prices roughly at the same price levels. A long shadow should extend to the downside, being at least twice the length of the body. The longer the shadow, the higher the selling pressure is applied and the higher the chance of a reversal.
The combination of these elements gives shape to a hanging man.
The hanging man candle is essential as it conveys the current market’s sentiment toward traders and analysts. If you look at the shape of the candle, you can break it down in how the traders see the current market sentiment as it reflects the impact of investors’ emotions on the pair’s price.
While the bulls or buyers have dominated price action, a large group of traders believe that the uptrend has peaked and it may be time for a correction or a pullback. Even though the price closed near the high, significant selling pressure was exerted, which resulted in a long wick lower, which indicates the growing presence of the bears in the game.
Overall, the hanging man pattern is bearish because the bulls had lost control over the price action for a certain period, which allowed the bears or sellers to move the pair’s price lower temporarily.
Then, it is crucial to mention that the hanging man doesn’t represent a direct trading signal. As we will see below, it should be used in conjunction with other technical analysis tools before you place a short trade.
How to spot it
It is quite easy to spot the hanging man candle. As outlined earlier, this formation should occur at the top of the uptrend; hence, you should be monitoring charts where the price action is moving higher.
To illustrate this, let’s consider a clear uptrend, where the price action has been creating a series of higher highs and higher lows. We can notice a slowdown in the uptrend as the pace of the new highs gets slower.
At one point, the price action creates a marginal fresh high, then is a correction or a minor pullback. After that, we can notice a candle that has a close price almost at the same level as the open price. Also, there is a long shadow below.
In this example, we have a hanging man candle at the top of the uptrend. This scenario is ideal since the actual hanging man candle has made the highest price in the uptrend. Afterward, we see a strong pullback, starting from the hanging man candle, but we will discuss that more thoroughly below.
How to trade the Hanging Man Candlestick Pattern
Whenever a current trend is ending, there are two scenarios that traders have:
- Those who are bullish are looking at options to lock their profits and close their trades.
- Those who want to profit on the potential trend reversal, and they are waiting for confirmation before placing a short trade.
In both scenarios, you can benefit from the message that the hanging man delivers. If you are already in a trade, the fact that you have evidence that suggests the trend is near its end is handy as you look at levels where you may close the trade.
On the other hand, the uptrend may be in its dying stages, and the reversal may be about to start. As a trader, this is potentially one of the best opportunities to make profits as a new trend hasn’t started yet.
Let us now look closer at how you should trade a hanging man candlestick, focusing on the second scenario where you are looking to capitalize on the change in the price direction.
After you spot the hanging man candle, you should wait for the next candle to confirm the initial signal generated by the hanging man. If the next candle is bearish as well, then the trend reversal is likely to have started.
Using Technical Analysis to confirm the reversal
Some traders also prefer consulting volume figures to validate the reversal idea further. Accordingly, a heavier trading volume implies that the reversal is taking place, as the low volume is unlikely to have the necessary strength to move the price action lower.
The idea of involving volume into the trading process is not a novelty as almost all reversal patterns need high volume to fuel the change in the trend’s direction.
In our example, we combined the hanging man candle with basic technical indicators. Hence, the red and blue lines show the previous price of two swing highs. Each level is expected to play an important role as the reversal is about to take place.
The hanging man is more likely to occur at price levels of more significant importance, like support and resistance levels. As the red line indicates the latest high, the price action creates a new high, although there is a hesitation which results in the hanging man.
As we know that this is a critical level to take into consideration, and the hanging man, as well as the next bearish candle, warn us on the potential reversal, we decide to open a short trade.
If we believe this is just a minor correction, we may consider taking the profit at the first level of support, in this case, the blue line.
We may place the stop-loss order above the recent high with a bit of room left in case there is a sudden whip to the upside.
Depending on your risk management and tolerance, you can adjust the take profit levels, either to nearby support or to lower levels.
In this particular case, the price action corrects lower around 100 pips in one movement.
Differences between the Hanging Man and other candlestick patterns
It is essential to clarify the key differences between the hanging man and other hammer candlestick family patterns like the hammer or the shooting star.
A hammer is of the same shape as the hanging man. Still, the crucial difference is that the former is a bullish reversal pattern that occurs at the bottom of a downtrend, while the latter is a bearish formation located at the top of the uptrend.
On the other hand, the shooting star is also bearish like the hanging man. However, the long wick of a shooting start extends to the upside. In contrast, the hanging man has a long shadow.
As you can see, the hanging man is like a shooting star turned upside down. They both signal that the uptrend is in the dying stages as the bears are growing in the game.
Strengths and Weaknesses
As every pattern, the hanging man is no different when it comes to having both strengths and weaknesses. Its apparent power is that it signals a potential reversal and the ending of the uptrend.
Moreover, a hanging man may further strengthen the idea that the reversal is coming, in case the trader has consulted other technical indicators which also point toward a correction in the pair’s price.
On the other hand, the formation shares a weakness with other candlestick patterns in the context that you should always consult other technical indicators, as well as fundamentals, to confirm a signal.
In general, the candlestick patterns and their messages are just one piece of evidence that you need to build the entire picture, which should ultimately result in the making of a well-informed decision on a trade.
Here are some key takeaways regarding the hanging man and how to practically use it in your daily trading routine:
- It is a bearish reversal formation that informs traders that the current uptrend is near the ending, and a reversal may take place soon
- It consists of a single candle, where the open, close and high are near almost the same, while a long shadow extending to the downside
- Although it is a powerful reversal formation, it should always be consulted with other technical indicators as it primarily generates a message and not a direct trading signal.
- A hanging man is not to be confused with a hammer (a bullish pattern) or a shooting star (a bearish pattern)