In our last lesson we learned about the bullish and bearish engulfing candlestick patterns. In today’s lesson I’m going to look at two more reversal patterns, which are known as the hammer and the hanging man candlestick patterns. So let’s get started.
The spinning top and doji, which we’ve studied in previous lessons, the hammer candlestick pattern is made up of one candle. The candle looks like a hammer as you can see here, as it has a long lower wick and a short body at the top of the candlestick with little or no upper wick. In order for the candle to be considered a valid hammer, most traders will say that the lower wick must be at least two times greater than the size of the body portion of the candle. And the body of the candle must be at the upper end of the trading range.
When you see the hammer form in a downtrend, this is a sign of a potential reversal in the market as the long lower wick represents a period of trading where the sellers were initially in control. But the buyers were able to reverse that control and drive prices back up to close near the high for the day. Thus the short body at the top of the candlestick there.
After seeing the pattern form in the market, most traders will wait for the next period to open higher than the close of the previous period to confirm that buyers are actually in control of the market. That’s pretty much true with any pattern that’s one candlestick. Most traders are going to wait for confirmation on the next period of trading before taking any action as a result of the pattern.
Two additional things that traders are going to look for on this one is, like some of the other patterns we’ve looked at, a long lower wick is going to increase the significance of the pattern. As well as an increase in volume on the period that forms the candle is also going to increase the significance of this pattern.
So let’s look at a chart here. You’ve got a chart of research in motion here, and we see we have a downtrend in the market. Then we have the hammer, which we can see formed here. Then we have increase in volume. On the day that formed the hammer we have the next candle, which opens higher than the close of the candle that formed the hammer. Then we do have a rally that comes after that in this specific example.
The hanging man is basically the same thing as the hammer, but instead of being found in a downtrend it’s found in an uptrend. Like the hammer pattern the hanging man has a small body near the top of the trading range, little or no upper wick, and a lower wick that is at least two times as big as the body of the candle.
Unlike the hammer, however, the selling pressure that forms the lower wick of the candle and then the candle closing in the upper end of its range is indicative more so of a sign of a potential reversal to the down side because the selling pressure is not anticipated in the uptrend.
The hammer, the selling pressure that forms a lower wick is expected because you’re in a downtrend, here the selling pressure is not expected, which forms the lower wick of the hanging man. So that’s a warning sign that there is selling pressure in the market. Especially if you’re in an overbought condition, those types of things you may start looking for a reversal there.
As with the hammer and as we said with most one-candle patterns, we’re going to wait for confirmation or most traders are going to wait for confirmation that selling pressure has in fact taken hold by watching for a lower open on the next candle. Traders are going to place additional significance on the pattern when there’s an increase in volume during the period that the hanging man forms as well as when there’s a longer wick.
Let’s take a look at an example of a chart here. We’ve got the uptrend, and then we have overbought conditions. You can see the market ran up there pretty significantly. We have the hanging man there. We don’t have an increase in volume on this one, but we do have the lower open on the next candle and an increase in volume driving that candle down lower really significantly.
A reversal pattern in play there, and obviously hindsight is 20/20 on this one. We may have missed out on that one had we been trading it live, but you can see a good example of a situation where the hanging man formed there.
How to trade the Hammer and Hanging Man Candlestick Chart Patterns for active traders. Like the Spinning Top and Doji which we have studied in previous lessons, the Hammer candlestick pattern is made up of one candle.
The candle looks like a hammer as it has a long lower wick and a short body at the top of the candlestick with little or no upper wick. In order for a candle to be a valid hammer most traders say the lower wick must be two times greater than the size of the body potion of the candle, and the body of the candle must be at the upper end of the trading range. When you see the Hammer form in a downtrend this is a sign of a potential reversal in the market as the long lower wick represents a period of trading where the sellers were initially in control but the buyers were able to reverse that control and drive prices back up to close near the high for the day, thus the short body at the top of the candle.
After seeing this pattern form in the market most traders will wait for the next period to open higher than the close of the previous period to confirm that the buyers are actually in control. Two additional things that traders will look for to place more significance on the pattern are a long lower wick and an increase in volume for the time period that formed the hammer.