Another great forex trend reversal and continuation pattern…
Hanging Man Pattern
SIGNAL: Bearish, Strong
This candlestick pattern consists of three individual forex candles. Unless otherwise stated, each individual candle can be either bullish or bearish. The three candles are:
- Setup Candle: The first candle is bullish and preferably occurs at the end of a significant push upwards in price.
- Signal Candle: The second candle is a hammer candle occurring at the top of the move. It consists of a comparatively short body with a comparatively long tail.
- Confirmation Candle: the third candle is a push down in price represented by a bearish body.
PSYCHOLOGY AND FUNDAMENTALS
The hanging man candlestick pattern sets up at the top of a move up in price, whether that move is part of a long-term trend or a short term retracement. The two scenarios are:
- It can occur at the end of a long run up which exhausts the supply of buyers and draws sellers into the market at the drastically inflated prices. At this stage sellers will be more inclined to enter the market on the offer of a currency pair at comparatively extended levels. Sellers have already begun to enter the market at the signal candle, pushing price down to a level that will likely shake the confidence of bulls. At this stage the buyers still appear to be in control, having managed to push price back up towards the highs. However, some buyers are beginning to exit the market as they take profit on the realisation that the surge upwards cannot last forever. Thus price falls.
- The hanging man can also occur in an downtrend when price temporarily retraces, preferably to a resistance level. This temporary move upwards may be due to sellers taking profit, buyers moving into the market at the relatively depressed prices, or just normal cyclical market exhaustion as the sell orders thin out. Hence price moves up to a level of resistance where sellers are ready to once more start moving into the market, pushing price down again.
TRADE ENTRY & STOP LOSS
You can enter either a Sell Stop order 2 to 5 pips in front of the lowest price the confirmation candle reached, or if you are confident enough of the move down you can enter aggressively with an At Market order. Either way, your Stop should go 2 to 5 pips behind the wick of the signal candle. This is a rough guide only: in volatile markets you may choose to extend the stop further out, and for much higher time frame charts such as the daily you may set stops 5 to 20 or even more pips behind the wick of the signal candle.
The larger the bearish candle that confirms the pattern, the more likely price will move downwards. However, if the confirmation candle is extremely long you may have trouble getting in with a reasonable reward to risk ratio.
For example, you may have to set a stop loss of 50 pips if the confirmation candle plus the signal candle combined represent around 50 pips. If there is a strong area of support only 20 pips below current price action, you may consider this to be a low probability trade and pass on the opportunity.
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