Let's go over Steve Nison's criteria:
We recognize both the hammer and hanging man (HM) from:
- the real body is at the upper end of the stick's range;
- the lower shadow should be at least twice the length of the real body;
- No or very tiny upper shadow.
- The longer the lower shadow, the shorter the upper shadow and the narrower the body, the more meaningful the pattern.
- In terms of stating the obvious, when used as reversal patterns, the hammer would come after a decline and the HM after a rally.
Confirmation of HM:
Nison says that at a minimum we need a lower open on the following stick, below the real body of the HM, but he usually recommends a close beneath the HM.
He also mentions that the pace of the rally should be slackening. The best way to determine this intraday is with the RSI which measures relative strength.
On the POT trade yesterday, which carved out 2 HM, the first of which was foreshadowing a reversal, we clearly see a negative divergence of the RSI to higher prices relative to the previous session.
On the FWLT chart, also from yesterday, we see the continued strength in the RSI when price prints a HM early in the session. This would not have been a good candidate to short following HM because the rally has yet to show signs of slackening.
The RIMM chart from today, shows 2 HM after a retracement. The RSI is clearly not enthused by the higher prices and this sets up a perfect short. If you use volume as the indicator, the entire retracement took place on declining volume.