Trading the Hanging Man Candlestick Pattern

Updated: August 6, 2016

The hanging man is a very popular, but often misused, candlestick trading signal. In this addition
to my price action course, my goal is to show you how to correctly identify and start trading the
hanging man candlestick pattern (in the right situations).

This popular candlestick formation is a weak reversal signal, and as a result, most experienced
candlestick traders do not use the hanging man alone as an entry signal.

Although the hanging man candle, when properly traded, is not typically used as an entry signal, it
can be a great heads-up indicator. Especially when combined with a good system for entry
triggers, this candlestick signal can be a powerful tool to have in your trading arsenal.

Note: I do not recommend pure candlestick trading with the hanging man, at least not
as an entry signal, unless it’s combined with a reliable trading system that has proven
to be profitable on its own.

What is a Hanging Man Candlestick Pattern?

The hanging man is a weak bearish reversal signal. This candlestick looks like the hammer
candlestick signal, only it appears at the top of a trend, or strong bullish price movement. Like the
hammer candlestick, the hanging man should have a long lower wick/shadow (at least 2x the size
of the real body), as well as little to no upper wick/shadow.

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 The real body of the hanging man signal can be bullish or bearish (see the image above). For
obvious reasons, this bearish reversal signal is considered to be slightly more bearish if the real
body is also bearish.

As I mentioned before, this candlestick formation is only considered to be a true hanging man
candlestick signal when it appears after an uptrend. The context in which you take any candlestick
signal is of utmost importance. Never trade candlestick signals from within price consolidation
(flat or sideways markets).

The psychology of this signal is that, even thought the bulls are still in control of the market, the
market has shown an ability to move lower (long lower wick/shadow). This can make the bulls a
little nervous, and some may start taking profits while they’re ahead.

Trading the Hanging Man Candlestick Pattern

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 In either case, these candlestick signals would have been a great place to take profits on a bullish
trade that you might have been in, which is how most successful candlestick traders use this
particular price action signal.

Example: You enter a bullish trade, riding the trend up as far as you can. When you
see the first hanging man (in the example above), you close half of your position. Upon
seeing the following bearish confirmation candle, you realize that you were right to be
suspicious of the trend continuing. However, price doesn’t break the low of the
confirmation candle, so you keep the other half of your position in play for now. Upon
seeing the second set of hanging man signals, you close your remaining position.

As demonstrated in the example above, you would have been wise to utilize this candlestick
formation as an exit signal. Of course, if you had closed your entire position after the appearance
of the first hanging man, your trade would have been almost as successful as the one described in
the example, without the extra risk.

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 In the image above, you can see another hanging man candlestick signal, with dashed lines
showing the proper entry and stop loss placement. Notice that the entry trigger is (1 pip) below the
bearish confirmation candle – not the hanging man itself. The stop loss is placed (1 pip) above the
highest high in the bullish cycle (current uptrend swing).

As I mentioned earlier, I do not recommend pure price action trading with the hanging man as an
entry signal. That being said, the technique above is the correct way to trade this signal as a entry
trigger if you choose to.

Also keep in mind that the hanging man can be a very high probability entry trigger when
combined with a good trading system. The Top Dog Trading system, for instance, teaches ways to
measure other energies in the market (cycle, momentum, support/resistance, etc.). When you
know what the other energies in the market are doing, it’s much easier to qualify high probability
candlestick signals.

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 In the image above, you can see another great example of how the hanging man candlestick
pattern can be used as an exit signal. There are some other indications that the bulls are running
out of steam in this example as well. Let’s look at them altogether to get a picture of how we could
have anticipated the bearish fall in price that followed:

1. The second large candlestick in the strong bullish move that preceded our hanging man
candlestick pattern made a huge move upward, but the market rejected price at those levels (see
the image above). This candlestick occurred to early in the trend to be considered a shooting star,
but the long upper wick/shadow is still relevant.

2. Price retested those levels that the market had previously rejected (as it often does), and made
some headway. However, while retesting those price levels, a hanging man candlestick signal
appeared. This is considered to be a bearish signal, especially considering that it appeared within
an area of such obvious rejection of price by the market.

3. The following candlestick is bearish, which is (depending on its relative size) a confirmation of
the bearish sentiment of the market at the time. This means that the bulls are probably getting
nervous, and taking profits on their open positions. This causes supply to go up, and price to go
down.

If you would have taken this particular hanging man candlestick pattern as an entry signal,
placing your stop loss above the hanging man itself, you would have gotten a nice risk to reward
trade. However, the correct place to put your stop loss, in this scenario, would have been above the
large upper wick/shadow that preceded the hanging man signal, because that is the highest high in
that particular bullish movement.

Note: Putting your stop loss in the correct place on this particular trade would have
yielded an unfavorable risk to reward scenario. So what do you do? You would simply
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 stay out of the market.

Successful trading means staying out of the market until conditions are perfect. Even
then you will lose trades, so don’t just trade for the sake of trading.

Final Thoughts

Keep in mind that candlestick trading is great for predicting short term market direction changes,
but there is never a guarantee on how long any particular market direction will last. This is
especially true with the hanging man, or any of the weak candlestick reversal signals.

The context in which any candlestick signal is traded is very important. A true hanging man
candlestick pattern can only appear after an uptrend in price. Never trade the hanging man, or any
other candlestick signal, during periods of price consolidation (flat or sideways markets).

As with any trading technique that you choose to try, wise money management skills will go a long
way toward ensuring your continued success. Take only the best trade setups, use your stop losses,
and make sure you are never overleveraged!

Steve Nison recommends combining Japanese candlestick trading with western technical
indicators to qualify the best trades. I personally use Nison’s candlestick techniques in
combination with the Top Dog Trading and Infinite Prosperity systems. This is a great
combination that has worked very well for me, but any reliable trading system could be combined
to help qualify these candlestick trades.

The hanging man is a very popular, but often misused, price action signal. Trading the hanging
man candlestick pattern can be very fun and rewarding, if you know how to trade it correctly. As
always, be sure to and demo trade this technique, until you have a firm grasp on it, before risking
any of your hard earned money.

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