Summary
This article explains the formation and implications of candlestick patterns in technical analysis. It explores the salient features of the Hanging Man and Hammer candlestick patterns. It also discusses the implications of the two formations, their chief differentiators, and the caveats a trader must keep in mind.
The Hanging Man and the hammer are forms of candlestick patterns that refer to their distinctive shapes depending on how the assets trade. But before we can understand their differences, we need to know the concepts of candlesticks from market and trading perspective.
What are candlesticks in charting?
Candlesticks are patterns made on charts using an asset’s opening, closing, high, and low prices, and pertain to a specific time frame, e.g., a day, a week, or a year. The candle is formed by the high and low prices for the asset. The candle’s wick is formed by the high price for security. The shadow represents the period’s low price for the asset.
A green or white candlestick indicates that the asset had a higher closing price compared to its opening price. If the candlestick color is black or red, it implies that the asset had a closing price which was lower than its opening price.
It must be noted that candlesticks taken in isolation do not determine future trading patterns. Market participants frequently rely on price and volume trends analysis, and other technical and fundamental indicators to base their trading decisions.
What is a Hanging Man candlestick pattern?
The Hanging Man is a form of candlestick pattern that refers to the shape and appearance of a candle. The Hanging Man appears as a short or no wick atop a small body (which is the candlestick), coupled with a long shadow below it. Traders dealing in candlestick patterns are of the belief that the formation of a Hanging Man pattern indicates the potential onset of a bearish trend.
As it is a trend reversal indicator, the Hanging Man formation must necessarily be preceded by an uptrend of some sort before a potential reversal can take place. Four conditions must exist for a Hanging Man pattern to emerge:
- The asset price has been on an upswing.
- The candlestick must have a short body, implying a narrow spread between opening and closing asset prices.
- The candlestick must also have a long lower shadow, indicating a very steep fall to the lowest price for the period.
- The candlestick may or may not have a wick. If it has a wick, the wick must be small.
While the Hanging Man pattern provides some guidance for traders, it isn’t an infallible investment strategy. The pattern does not provide price targets for the asset and can potentially indicate short-term price reversals only.
What is a Hammer candlestick pattern?
The Hammer candlestick pattern emerges when an asset trades significantly below its opening price during a particular period but rallies enough to close near its opening price. This price pattern resembles a hammer-shaped candlestick, which is characterized by a small body with the long lower shadow making up at least two-times the size of the candle’s body. The shadow represents the high-low prices of the security for a particular period.
Candlestick traders consider that the Hammer pattern is potentially indicative of a reversal in a bearish trend. As the asset’s price are expected to trend upward following a Hammer pattern, a subsequent increase in price is referred to as confirmation. A Hammer pattern does not indicate an upward reversal in price until it is confirmed. Confirmation happens when the subsequent candlestick’s closing price is higher than the closing price of the hammer.
Like the Hanging Man candlestick pattern, the Hammer too is not without its shortcomings. The lack of a price target implies traders do not get clues of when to enter or exit the market. It can also be a frustrating technical indicator as confirmation does not imply that the asset price will continue to move higher.
What is the difference between a hanging man and a hammer formation?
While both the Hammer and the Hanging Man are candlestick patterns, there are significant differences amongst the two formations:
| Hanging man | Hammer |
| The Hanging Man candlestick pattern resembles a hanging man | The Hammer formation looks akin to a hammer |
| During a Hanging Man candlestick pattern session, the market’s bears put selling pressure on the asset pushing the price down. This is so low that it is the lowest price for the asset, and far away from the asset’s opening price. Subsequently, market bulls come back into the fray, pushing the asset’s price up. This back-and-forth between traders continues until closing, when the asset’s opening and closing are near the high, while the low for the period is significantly lower than the body | A Hammer candlestick pattern is formed when an asset’s price falls from its opening level due to selling pressure. However, due to a market bottom being reached, the asset’s price recovers to close near its opening price during the same period under consideration |
| A Hanging man formation is seen when an uptrend in asset price is about to reverse making it a bearish indicator | A Hammer formation indicates that a downtrend in asset price is about to reverse making it a bullish indicator |
| The Hanging Man provides a market peak or price resistance level and are typically seen as market exit points | The Hammer pattern provides a price support or a market bottom level thus providing market entry opportunities for traders |
Conclusion
Both hammer and hanging man candlestick patterns are critical for traders’ understanding. However, always practice caution and never go in uninformed. On balance, both candlestick patterns should be used in conjunction with other technical and fundamental indicators to base trading decisions.