The hanging man candlestick is a bearish trend reversal pattern that occurs during an uptrend and can signal the top of that uptrend. The long lower shadow of the candle signifies that bears were able to push prices down during the day showing that there is some vulnerability to the downside. However, the bulls were able to bring prices back up to close roughly where the trading session started. It is important to wait for confirmation that the trend has indeed changed to bearish. This confirmation occurs when the next trading session’s close is below the hanging man’s real body (Nison, 1994, p. 60). If the next trading session’s close is above the hanging man, then the hanging man candlestick pattern is void.
The hanging man candlestick is defined next:
- Usually the hanging man has no upper shadow or a very small upper shadow.
- The real body should be at the top of the candlestick trading range. The real body can be bullish or bearish, but with the hanging man it is preferable to be bearish.
- The lower shadow of the hanging man should be at least two times the height of the real body.
The defaults for the hanging man candlestick pattern in a typical computer charting program are shown below (ThinkorSwim, 2011):
- The real body of the hanging man is 30% of the average real body height over the past 20 trading sessions.
- The lower shadow must be at least 2 times the height of the real body.
- The trend over the past 3 trading sessions is upward.
Nison (1991) states: “The longer the lower shadow, the shorter the upper shadow and the smaller the real body the more meaningful the bearish hanging man. . .it is slightly more bearish if the real body of the hanging man is black.” The reason it is more bearish if the real body of the hanging man is bearish is that bulls were unable to return prices back to the level of the open, the bulls actually lost ground for the day; this suggests that the prior bullish uptrend might be losing power and a trend change could occur over the next few trading days.
Psychology of Hanging Man Candlestick Pattern
The reason the hanging man candlestick pattern requires a second day confirmation is explained through market psychology. Usually the most active parts of a trading day is its opening and closing. Since by definition the opening and closing of the hanging man occur at the top end of the candle, any traders that bought at the opening and closing are losing money if the next day the trading session opens lower. Depending upon how severe the bearish candle is to the downside, the traders that bought at the open or close of the hanging man trading day might give up, especially if an uptrend has been broken, and sell out at a loss, precipitating a further selloff and confirming that the hanging man was indeed a top. In contrast, if the day after the hanging man candlestick opens higher, the traders that bought at the open and close of the hanging man are in winning positions and see no reason to sell because this is just a continuation of the uptrend prior to the failed hanging man pattern.
Hanging Man Confirmed by Second Day Lower
The chart above of the Dow Jones Industrial Average ETF (DIA) shows an upward price channel topped with a hanging man candlestick. Notice how the hanging man candlestick opened higher than the top price channel and closed above the price channel; therefore looking like a breakout has just occurred. Unfortunately for the bulls, the next day gapped down. As a reminder about the psychology of the hanging man pattern, traders who bought the open and close are now in a losing position, having fallen for a false breakout. In trading parlance, these traders are “left hanging” and are likely to cut their losses, thus adding more selling pressure to the ETF. In this example, the hanging man was the beginning of a multi-month downtrend.
Hanging Man Voided by Second Day Higher
The chart above of the Gold ETF (GLD) shows the price moving steadily higher when a hanging man appears. However, the next day’s open was higher than the hanging man’s close and the next day’s bullish candle closed higher than the hanging man’s high. This obviously does not conform to the common rule of requiring the second day candle to open below the real body of the hanging man candlestick and thus voids the hanging man reversal signal.
- Kirkpatrick II, C.D., & Dahlquist, J.R. (2010). Technical Analysis: The Complete Resource for Financial Market Technicians (2nd ed.). Upper Saddle River, NJ: FT Press.
- Rockefeller, B. (2011). Technical Analysis For Dummies (2nd ed.). Hoboken: John Wiley & Sons.
- The Pattern Site. (2008). Bulkowski's Measure Rule. Retrieved June 1, 2012, from http://thepatternsite.com/measure.html