In this review, we will look at two reversal candlestick analysis patterns: The Hanged Man and the Inverted Hammer. The appearance of these patterns on the price chart gives a signal about the possible beginning of a correction or a trend reversal.
How are these patterns formed?
Patterns Hanging Man and Inverted Hammer) refer to reversal candlestick analysis patterns. Candlestick analysis came to financial markets from the Land of the Rising Sun; a well-known trader and analyst became its active popularizer Steve Nison… Due to its informativeness and convenience for visual perception, candlestick analysis is deservedly popular among traders around the world.
Formation of the “Hanged Man” pattern
The “Hanged Man” reversal pattern is formed at the highs of the price chart after the previous upward movement. The pattern is represented by a candlestick with a small body (color does not matter), with a missing or small upper shadow and a very long lower shadow, which should be at least twice the size of the candlestick body. Visually, this candle seemed to the Japanese to look like a hanged man, which is why the pattern got such a gloomy name.
The essence of the “Hanged Man” pattern is that during an upward movement in the market on some day, a strong sale of the asset occurs, after which buyers try to return quotes to the highs again, as evidenced by the long lower shadow of the candlestick. There comes a moment of uncertainty – the bears have activated and are ready to launch a counterattack, but the bulls still have strength and hope to break their resistance.
The key factor showing who comes out the winner in this confrontation will be the closing of the next candle after the “Hanged”. If it is a bearish candlestick with the closing price below the body of the Hanged Man, then the reversal pattern is fully formed, and we can expect a further decline. Otherwise, if the bulls manage to confidently close the day in their favor, there will be no confirmation of the pattern: the reversal signal is canceled, and most likely the uptrend will continue.
Formation of the “Inverted hammer” pattern
The Inverted Hammer reversal pattern is a mirror image of the Hanged Man pattern. Appears at the lows of the price chart during a downtrend. The pattern looks like a candlestick with a small body (color does not matter), with a missing or small lower shadow and a very long upper shadow, which should be at least twice the size of the candlestick body. Visually, this candle resembles a hammer turned upside down, which served as the basis for the name of this model.
The essence of the Inverted Hammer pattern is that during a downward movement in the market, at some point, an active purchase of a financial instrument occurs, after which the bears manage to return prices to recent lows, as evidenced by the long upper shadow of the candlestick. Uncertainty sets in on the market – the bulls are trying to seize the initiative and turn the upward movement, but the bears are still strong and hope to roll their horns.
We also evaluate the development of the pattern by how the next candlestick after the appearance of the Inverted Hammer closes. If it is a bullish candle with a closing price above the Inverted Hammer body, then a reversal pattern has formed, and the bulls will probably be able to reverse prices up. If a bearish candle appears, the pattern is not considered completed; further continuation of the downward trend is possible.
Trading the Hanged Man and Inverted Hammer Patterns
The “Hanged Man” and “Inverted Hammer” candlestick patterns are quite versatile, they can be used for trading in various types of markets: stock, commodity, Forex and others. They can be used on charts with any periods, but they show themselves most effectively on higher timeframes: H4, daily, weekly. To increase the effectiveness of working out, candlestick patterns are recommended to be used in combination with signals from trading indicators and technical analysis support and resistance levels.
Hanged Man pattern – sale
The pattern trading algorithm is as follows:
- At the high of the price chart, during the upward movement, a candle with a small body and a long lower shadow – “The Hanged Man” was formed.
- We are waiting for confirmation that the pattern has been formed: the next candlestick needs to be black and its closing price is below the body of the Hanged Man.
- We open a sell position, set a stop beyond the maximum of the pattern, profit can be fixed when a significant support area is reached or when signs of the end of a downward movement appear.
Inverted Hammer pattern – buy
The trading algorithm for the Inverted Hammer pattern looks like this:
- A candlestick with a small body and a long upper shadow – “Inverted Hammer”, has formed at the low of the price chart during the downtrend.
- You need to wait for confirmation that the pattern has been formed: the next candlestick should be bullish and its closing price is above the Inverted Hammer’s body.
- We open a buy position, set a Stop at the minimum of the pattern, Profit can be fixed when a strong resistance area is reached or when signs of the end of an upward impulse appear.
The “Hanged Man” and “Inverted Hammer” reversal patterns are formed at the local extremes of the price chart during the uptrend and downtrend. Their appearance heralds the beginning of a correction or a possible trend reversal. The probability of their working out increases in combination with technical analysis figures, support and resistance levels, signals of trading indicators. Before starting real trading, you should test the development of these patterns on historical data.
You can get acquainted with other candlestick patterns in this article: