What is the Hanging Man Pattern?
The Hanging Man pattern is almost identical to the Hammer pattern. Like the Hammer pattern, the Hanging Man pattern is a single candlestick pattern and a trend reversal pattern that consists of an umbrella line. The major difference is that the Hanging Man pattern can appear in an uptrend, making it a bearish trend reversal pattern, and because the umbrella line is bullish, it is a moderate trend reversal pattern that warns of the possible end of the current uptrend.
The Hanging Man has another counterpart called the Shooting Star that also appears in an uptrend but has a long upper shadow rather than a long lower shadow.
The Hanging Man Formation
Like the Hammer pattern, the Hanging Man pattern consists of a single candlestick that is called an umbrella line. An umbrella line is a long candlestick with a short real body located at the top end of the trading range, a long lower shadow, and very little or no upper shadow. The lower shadow must be at least twice the length of the real body giving it the appearance of a Hanging Man with dangling legs.
The color of the Hanging Man pattern's real body is not important, but its size, in relation to its shadows, is. The real body must be short and must be located at or very near the top of the price range. In other words, it must have very little or no upper shadow otherwise the close would not be near the top of the range and the candlestick would have the form of a Spinning Top rather than a Hanging Man . The length of the lower shadow is also important and must be at least two or three times longer that the real body of the Hanging Man .
What the Hanging Man Pattern tells us
Usually, the long lower shadow of an umbrella line a bullish signal as it indicates that the underlying instrument sold off during the session but this sell-off was overcome by greater buying which forced the price to bounce back up from its lows to close at or near the high for that session. However, when taken in the context of the current uptrend, the length of the lower shadow shows a degree of weakness in the trend as the price was driven down before bouncing back up again. More so when the Hanging Man is compared to the prior candlesticks that were more bullish, especially if they had long real bodies! Essentially, this weakness is tentative and would require some sort of confirmation before being acted upon.
Trading the Hanging Man Pattern
As mentioned earlier, the long lower shadow of the Hanging Man is generally a bullish signal, indicating that demand for the underlying security overcame an earlier sell off and forced the price into the upper end of the price range for that session. And as the Hanging Man pattern is a potential bearish signal, confirmation of the weakness in the trend, in the form of another bearish candlestick pattern, such as an Engulfing pattern or a Piercing pattern, or a close below the real body of the Hanging Man would be recommended. A short position would be taken against the major trend and would therefore carry increased risk. Thus, a protective stop loss should be placed above the high of the Hanging Man pattern.
Alternatively, the Hanging Man pattern could be used to close an existing long position rather than entering a new short position. After the Hanging Man has completed, a subsequent close below the real body of the Hanging Man would indicate that a bearish reversal is more possible and traders could consider closing their long positions. In the short term, following the Hanging Man pattern, traders could watch out for the appearance of a bearish candlestick pattern, such as the Evening Star, the Dark Cloud Cover, or the Falling Three Methods pattern, as these could herald the start of a downtrend and could be used to enter a short position.
The Hanging Man pattern also does not provide a profit target. Instead, some other trading mechanism can be used to exit the trade. This could be a Fibonacci retracement level, the appearance of a bullish candlestick formation, or a simple trailing stop.
The Hanging Man pattern becomes a bit more reliable when the underlying security is making an all-time high, or when the Hanging Man appears in an extended or significant rally.