The Hammer and the Hangman Candlestick Patterns are Important Reversal Signals

Illustration: Currency
This is a guest post by Ahmad Hassam

The hammer, the hangman and the doji are some of the few most important candlestick patterns that every trader should recognize. Both the hammer and the hangman have a small real body and a long lower shadow with almost no upper shadow. To be a hammer or a hangman, the shadow should be at least two times the body (the longer the shadow the more significant the pattern). However, it is very easy to confuse hammer with the hangman.

How to tell this is a hangman and this is a hammer. Hangman is like a person who has been hanged with legs dangling underneath. Hangman always occurs in an uptrend. A hammer is almost similar to the hangman. The only difference is that it appears in a long downtrend. So the key difference is where both occur. The hammer appears after a long downtrend when the market is oversold. On the other hand, a hangman appears after a long uptrend when the market is overbought.

Appearance of a hammer or a hangman is an important signal that the market has reached the bottom or the top. When you spot any one of these two patterns, you need to confirm it using other indicators. There are many overbought and oversold indicators like the Stochastic, CCI, RSI or the Williams’ %R. So when both the stochastic, CCI or the Bollinger Bands agree and there is a candlestick reversal pattern like the hangman or the hammer, it means that the market has most probably reached the top or the bottom.

Candlestick patterns work very well on the daily charts. Appearance of a candlestick pattern like the hammer and the hangman should not be taken in isolation. So when you spot the candlestick pattern hammer or the hangman, you should first confirm it with the Stochastic as well as the Bollinger Bands.

In case of a hangman, the Stochastic should give an overbought reading. If you also want to use Bollinger Bands for confirmation, the hangman close should appear outside BB upper band indicating the market is overbought.
On the other hand, in case of the hammer, the Stochastic or the CCI indicator should give an oversold reading. In the same manner, the hammer close should be below the lower BB band indicating the market is oversold.

On the daily charts, a candlestick pattern like the hammer or the hangman will appear most of the time first followed by the same overbought or oversold signal by the Stochastic or the CCI often a day later. So if you want to act immediately on the hangman or the hammer, confirm the oversold or the overbought market using the Bollinger Bands as explained above. In case you want to be more cautious, you can take further confirmation with the Stochastic or the CCI.

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