Everything You Need to Know About the Hanging Man Pattern
Candlestick patterns form the backbone of technical analysis. They reflect the market sentiment and are very useful for speculating whether a trend is likely to continue or a reversal is in the offing. The hanging man is among the simplest patterns, as it is formed by a single candlestick. A single candle already packs in a lot of information, including opening and closing prices and the session’s highest and lowest prices. The hanging man tells us whether market sentiment is shifting from bullish to bearish.
Understanding the Hanging Man Pattern
This pattern signals a potential bearish reversal. It indicates that an uptrend is about to end and there could be a pullback in prices.
Spotting the Hanging Man Pattern
Here are the characteristics of a candlestick that can be considered as the hanging man pattern:
- Occurs after a sustained uptrend (rally)
- Has a very small body
- Little to no upper shadow (wick)
- Usually red (bearish) before a reversal
- Has a long lower shadow (wick), at least twice the size of the body
What if the colour of such a candle is green? That is also a bearish reversal signal, but a very weak one. It indicates that even though buying pressure is fading, bears are unable to exert any control. You may choose to trade this if you have a high risk appetite.
Advantages of the Hanging Man Pattern
The biggest reason for this pattern’s popularity is that it involves only a single candlestick. This makes it quick and easy to identify. There are several other advantages as well:
Leading Indicator
Many candlestick patterns are lagging indicators. This means they show a change in sentiment after it has happened. The hanging man is a leading indicator of a bearish reversal. Being an early signal, it allows bulls to exit their positions in good time and bears to timely open short trades.
Reveals Potential Entry and Exit Points
When used in combination with other technical indicators, it can provide insights into support and resistance levels. These turn into potential entry and exit points.
Applicable to Diverse Markets
The hanging man candlestick pattern can be applied to any asset that is in an uptrend.
Limitations of the Hanging Man Pattern
No single chart pattern is foolproof and must never be used in isolation. But how to choose the right technical indicator to complement the hanging man? Knowing the shortcomings of the pattern can help you supplement it with the most suitable technical indicator. Some of the limitations of the hanging man candlestick pattern are:
- It does not indicate bearish momentum or the strength of the downtrend.
- It looks very similar to the hammer and the Doji patterns, which can confuse new traders.
- It does not take into account the trading volume.
- It can generate false signals, which is why confirming a signal before acting is necessary.
Trading with the Hanging Man Candlestick Pattern
Here’s a strategy to identify and trade bearish reversals using the hanging man candlestick pattern:
Wait for a Confirmation Signal
It is necessary to confirm the signal of a chart pattern, as markets can be influenced by news updates or broader sentiment. These turn the signal to a false positive.
A long bearish candlestick that follows the hanging man pattern confirms the signal. Traders observe the length of the body – the longer it is than the hanging man, the stronger the signal for a bearish reversal. This candlestick should ideally have little to no lower wick, indicating strong trading volume at the low price. Traders tend to enter short positions when the bearish confirmation candle closes below the low of the hanging man.
Use Resistance Levels
Usually, selling pressure is high near the resistance levels. A hanging man near resistance is considered a strong signal of a potential bearish reversal. Technical indicators, such as the Fibonacci ratios or the Ichimoku Cloud, help identify resistance levels or zones.
Determine Trading Volume
High volume means there is more conviction in the market. Technical indicators like On-Balance Volume (OBV) can be used to determine if the upward momentum is weakening. When the uptrend shows divergence from the OBV, which may be flat or falling, it means bullish sentiment is weakening. When this happens in the period of the hanging man candlestick, traders consider it a strong reversal signal. Other technical indicators that can be used to determine volume are Bollinger Bands, Accumulation/Distribution, and volume-weighted average price (VWAP).
Set Risk Limits
When going short after the formation of the hanging man, the stop loss can be placed near the high of the pattern. This limits risk exposure in case the market reverses. Traders can place their take-profit limits near the support, as indicated by support indicators.
Backtest Your Strategy
The key to trading with confidence is practising on a demo account. This allows you to fine-tune your strategy to different market conditions.
To Sum Up
- The hanging man occurs after an uptrend and is a leading signal of a bearish reversal.
- This pattern is more reliable when it occurs after a strong uptrend and forms near the resistance level.
- It is better to confirm the pattern before opening or closing a position.
- Volume acts as a confirmation of the intensity of selling pressure.
- The pattern can be combined with RSI, Fibonacci, Bollinger Bands, and other technical indicators.
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