Tuesday, February 10, 2009

Bearish Hanging Man Reversal Pattern

Following last night's trading post, we had some interesting questions on the correct timing and entry of the bearish hanging man candlestick reversal pattern.

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.
My notes - this second last point is a problem when it comes to stops, that's why I don't like to trade off of a wide HM or hammer. I usually wait for a lower risk entry point. I also prefer my hammers to be green and my HM to be red, but Nison says color is less important.

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.

8 comments:

Jim said...

Nice lesson!

Jamie said...

Thanks Jim.

Golden Bear said...

Jamie,

Really appreciate you taking the time to explain the subtleties. Hopefully, my trading will reflect the wisdom you imparted. Thanks!

TraderLars said...

NO!!!!!!!!!!!!!!!!

AN INDICATOR???? SHAME SHAME!!


lol jk... nice lesson

Jamie said...

Welcome Golden Bear,

I like doing these types of posts. Helps keep the blog from getting stale.

Jamie said...

Hey Lars,

Yeah, I hear ya. I'm not advocating trading off of indicators, but sometimes they help confirm whether or not the setup is ripe.

Joao Henrique said...

Hey Jamie,

Always good stuff here. Long time without posting comments but your blog is my everyday reading.

I like shooting stars and hammers better I think they signal better a reversal. The range expansion is a plus, despite your stops get wider, they have more shock value.

Range expansion means traders were excited and were caught on the wrong side of the marked.

Jamie said...

Thanks Joao,

Good observation. I like shooting stars and hammers too. They alert me that there's a reversal in play and that I want to find a low risk entry point.