Last Updated on 21 September, 2020 by Samuelsson
Candlestick charts indeed are popular nowadays and have surged to become the preferred charting method of many traders. When candlesticks are combined together, they form candlestick pattern of which there are many variations, all telling us a unique story about what the market has been up to. One such candlestick pattern is called “hanging man”, and that’s the topic for this article.
A hanging man is a single candlestick pattern that forms after an uptrend. It’s a reversal pattern, which means that it’s believed to precede a market downturn. As to the characteristics of the hanging man pattern, its body is small, and confined to the upper half of the range, with a long wick to the downside.
In this article, we’ll cover how to spot a hanging man candlestick, its meaning, and some example strategies that make use of it.
How to Identify a Hanging Man
Being a one candle pattern, the hanging man is quite easy to spot. Here are the things you need to look for:
- The real body of the candlestick must be in the upper half of the range. It doesn’t matter if it’s bullish or bearish (red/black).
- The upper wick is tiny or absent.
- The lower wick is at least twice the size of the real body
IMPORTANT! For a hanging man to be a hanging man, it must be preceded by an uptrend. Otherwise, it’s categorized as a hammer candlestick. We’ll come to that in just a bit!
What Does a Hanging Man Mean?
Every candlestick tells a different story about the market forces. Now, of course, this shouldn’t be taken too seriously. However, it’s a very good exercise when it comes to learning how to analyze price action and interpret the market.
Since the hanging man forms in an uptrend, the market and its momentum are bullish. Most market participants are eager to see their positions appreciate, and believe that the market is going to continue up.
However, as the market opens the next day, it starts to head lower. The selling pressure increases and pushes the market down. However, soon the buying pressure increases again, and people who still believe in the uptrend start to look for bargain prices. As such, the market heads higher again and manages to close around the open.
What now is a full-fledged hanging man pattern invokes fear in the market, and the continuation of the bullish trend isn’t as obvious anymore. As such, more market players decide to get out of the market. The consequence becomes that selling pressure increases and pushes the market further down. The bearish trend or pullback has begun!
How to Improve the Accuracy of the Hanging Man
Most traders who use patterns such as the Hanging Man don’t take a trade as soon as they see a pattern. With most patterns, that’s not an option that will lead to profitable trading.
Instead, you will have to find the right timeframe and market where the pattern works, and then apply filters to increase the profitability of the signal.
Now, different markets and timeframes will require different types of filters. However, below follow some of the filters and conditions that we have found work well in our own trading!
1. Use Seasonality
Now, some patterns might not work that well on a certain day of the week. It could be that certain days have a bearish or bullish bias, that skews the results.
For example, some gap strategies might work poorly on Mondays, since the weekend inevitably brings some quite big gaps once in a while. And those external factors, like the market being closed for two days in this example, could trick our strategy by creating false signals.
Now, if there is a day of the week in the market that seems to be extra bearish, then you perhaps should take that into account. If a hanging man is formed on one of those extra bearish days, then it might not be as significant as if it was formed on a day that’s historically has been very bullish.
Another seasonality-related factor you might want to account for is the day of the month. Now, you shouldn’t go and pick random dates that look great in a backtest, but look for broader tendencies. For example, it might be that a pattern works reliably in the first half of the month, but yields terrible result in the second half.
One of the most well-documented effects of this kind is the turn of the month effect. In short, it means that a disproportionately large amount of the returns of the S&P-500 is made at the turn of the month.
2. Use Volume
A price chart only gives you information about how the market moved. While this is all you need to build profitable and working trading strategies, you could benefit from knowing a little more than that. More specifically, you could benefit from having access to volume data.
With volume you don’t only get to know how the market moved, but also the conviction of the market. Having access to that information in your analysis could add a lot of extra value, in certain cases.
When it comes to using volume with the hanging man pattern, you have many approaches to choose from. However, two of the most common are the following:
- Measure the volume of the hanging man relative to surrounding candles
- Require the volume preceding the pattern to be declining or rising.
Of these two approaches, the first one is probably the most widely used. Here you simply look at the volume when the pattern was formed, and compare that to volume of the surrounding candles.
Now, you could require that the volume is higher or lower than the surrounding bars. Depending on the market and timeframe, either of the two could work well.
The second option, which involved looking at the volume preceding the pattern, could be used in either way as well. Here you could try and use a moving average, to smoothen the volume data, which typically is quite choppy. Then you just have to see if the moving average is rising or falling.
3. Consider the size of the Hanging Man Pattern
Another way of gauging the significance of the pattern is to look at the range of the hanging man candle relative to other bars. Typically, the bigger the range, the more significant the pattern gets.
Now, in the case of the hanging man, you might want to consider breaking down the pattern into the wick, and the real body. The reason is that you generally want the wick to be quite long, while the real body should remain quite short. A longer wick indicates that the bears managed to push the prices lower, which adds to the bearish sentiment change!
4. Wait for Confirmation
One common approach to the hanging man pattern is to wait for a confirmation before taking a trade. More specifically, this means waiting for the market to go below the low of the pattern before taking a trade.
Now, this could have two effects:
- You get a more reliable signal
- You enter too late, and the market already has made its move, leaving you with a loss.
When deciding which approach to go for, both these factors come into play and should be considered.
This is something you will see quite often. A higher winning percentage often means bigger losses for those losing trades, and vice versa.
Hanging Man Trading Strategies
In this part of the article, we’ll have a look at some trading strategies that make use of the hanging man pattern.
Just be aware that the strategies presented are not meant to be traded live. Instead, they are some examples of how we would go about when building a trading strategy ourselves. If you’ve read our article on how to build a strategy (a recommended read!) then these examples here would fall into the first step of the process.
Having said this, let’s have a look at some example strategies. Hopefully, these will spark ideas that you could build great trading strategies from!
Strategy 1: Hanging Man and an Uptrend Condition
Since a hanging man occurs when the bullish trend is believed to have come to an end, you could try to measure the length of the trend, and only take a signal if the bullish trend is longer than the threshold you set.
The best way of doing this probably is to measure the length of the last uptrend, and decide only to enter a position if the current uptrend is longer than the previous one.
The goal is to define when the trend is starting to become old, since it’s much more likely that a hanging man will be profitable if the bullish trend is approaching the end of its lifespan.
So, here are the rules for the strategy:
- A hanging man
- The current trend is bullish, and longer than the previous bullish trend. You measure the length as the distance from the low to the high.
You then exit the trade after 5 bars.
Strategy 2: Hanging Man and a Volatility Filter
Another way of defining that the bullish trend is coming to an end is with the ADX indicator. If you see that the market has trended with quite a lot of strength and see how the market is now weakening, it could be a sign that the bullish trend is approaching its end.
Now, with the help of the ADX indicator you could define the above scenario as follows:
- The ADX reading during the middle of the trend is high
- As the market continues up, the trend strength diminishes, meaning that the ADX is in a downtrend.
So, with our strategy example, we’ll enter a trade if:
- There is a hanging man
- The ADX conditions outlined above are true. We use the 14-period ADX, which is the standard-setting.
The stop loss will be placed two ATR(Average True Range)-lengths from the highest high of the trend, and the profit target will be placed 3 ATR-lengths away from the low of the hanging man.
Strategy 3: Hanging Man with RSI
In the first strategy example, we used a declining ADX reading to know when to act on a hanging man signal.
A different way to use the same principle, would be with volume instead.
And to add our own twist to it, we decide to use the RSI indicator to measure volume.
Here follow the rules for this strategy:
- A hanging man
- The 10-period Volume RSI is in a downtrend.
Then we exit the trade after 5 bars.
Hanging Man vs Hammer Candlestick
The hammer and hanging man candlesticks are the same pattern, with one major difference. While a hanging man occurs after an uptrend, a hammer occurs after a downtrend and signals a bullish reversal of the trend.
Knowing this, you should really pay attention to if the hanging man is preceded by an uptrend or downtrend!
Here you can read more about the hammer pattern
In classic technical analysis, the hanging man pattern forms during an uptrend, and is believed to signal a reversion of the trend.
In this article, we’ve covered the meaning of the hanging man pattern, how to spot it, and provided a couple of trading strategies that you could use for inspiration.
We once again want to stress the importance of creating your own trading strategy. Have a look at our article that covers the step-by-step process of building a trading strategy, if you haven’t already!