In our last lesson we learned about the Bullish and Bearish Engulfing Candlestick Patterns which can represent reversal patterns when found in an uptrend or a downtrend. In this lesson we are going to look at two more candlestick patterns which are known as the Hammer and the Hanging man.
Like the Spinning Top and Doji which we have studied in previous lessons where we learn to trade chart patterns, 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 chart 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
The Hanging Man
The Hanging Man is basically the same thing as Hammer formation but instead of being found in a downtrend it is 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 in the Hanging Man is seen as a potential sign of more selling pressure to come, even though the candle closed in the upper end of its range. While the lower wick of the Hammer represents selling pressure as well, this is to be expected in a downtrend. When seen in an uptrend however selling pressure is a warning sign of potential more selling pressure to come and thus the categorization of the Hanging Man as a bearish reversal pattern.
As with the Hammer and as with most one candle chart patterns most traders will wait for confirmation that selling pressure has in fact taken hold by watching for a lower open on the next candle. Traders will also place additional significance on the pattern when there is an increase in volume during the period the Hanging Man forms as well as when there is a longer wick.