The image above shows candlesticks with long lower shadows and small real bodies. The real bodies are near the top of the daily range. The variety of candlestick lines shown in the image are fascinating in that either line can be bullish or bearish depending on where they appear in a trend. If either of these lines emerges during a downtrend it is a signal that the downtrend should end. In such a scenario, this line is labeled a hammer, as in “the market is hammering out” a base.
Interestingly, the actual Japanese word for this line is takuri. This word means something to the affect of “trying to gauge the depth of the water by feeling for its bottom.”
If either of the lines in the images emerge after a rally it tells you that the prior move may be ending. Such a line is ominously called a hanging man (see below image).The name hanging man is derived from the fact that it looks like a hanging man with dangling legs.
It may seem unusual that the same candlestick line can be both bullish and bearish. Yet, for those familiar with Western island tops and island bottoms you will recognize that the identical idea applies here. The island formation is either bullish or bearish depending on where it is in a trend. An island after a prolonged uptrend is bearish, while the same island pattern after a downtrend is bullish.
The hammer and hanging man can be recognized by three criteria:
- The real body is at the upper end of the trading range. The color of the real body is not important
- A long lower shadow should be twice the height of the real body.
- It should have no, or a very short, upper shadow.
The longer the lower shadow, the shorter the upper shadow and the smaller the real body the more meaningful the bullish hammer or bearish hanging man. Although the real body of the hammer or hanging man can be white or black, it is slightly more bullish if the real body of the hammer is white, and slightly more bearish if the real body of the hanging man is black. If a hammer has a white real body it means the market sold off sharply during the session and then bounced back to close at, or near, the session’s high. This could have bullish ramifications. If a hanging man has a black real body, it shows that the close could not get back to the opening price level. This could have potentially bearish implications.
It is especially important that you wait for bearish confirmation with the hanging man. The logic for this has to do with how the hanging-man line is generated. Usually in this kind of scenario the market is full of bullish energy. Then the hanging man appears. On the hanging-man day, the market opens at or near the highs, then sharply sells off, and then rallies to close at or near the highs. This might not be the type of price action that would let you think the hanging man could be a top reversal. But this type of price action now shows once the market starts to sell off, it has become vulnerable to a fast break.
If the market opens lower the next day, those who bought on the open or close of the hanging-man day are now left “hanging” with a losing position. Thus, the general principle for the hanging man; the greater the down gap between the real body of the hanging-man day and the opening the next day the more likely the hanging man will be a top.
Another bearish verification could be a black real body session with a lower close than the hanging-man sessions close.
The above image is an excellent example of how the same line can be bearish (as in the hanging-man line on July 3) or bullish (the hammer on July 23). Although both the hanging man and hammer in this example have black bodies, the color of the real body is not of major importance.
This one above shows another case of the dual nature of these lines. There is a bearish hanging man in mid-April that signaled the end of the rally which had started with the bullish hammer on April 2. A variation of a hanging man emerged in mid-March. Its lower shadow was long, but not twice the height of the real body. Yet the other criteria (a real body at the upper end of the daily range and almost no upper shadow) were met. It was also confirmed by a lower close the next day. This line, although not an ideal hanging man, did signal the end of the upturn which started a month earlier. Candlestick charting techniques, like other charting or pattern recognition techniques, have guidelines. But, they are not rigid rules.
As discussed above, there are certain aspects that increase the importance of hanging-man and hammer lines. But, as shown in the hanging man of mid-March, a long lower shadow may not have to be twice the height of the real body in order to give a reversal signal. The longer the lower shadow, the more perfect the pattern.
The one above shows a series of bullish hammers numbered 1 to 4 (hammer 2 is considered a hammer in spite of its minute upper shadow). The interesting feature of this chart is the buy signal given early in 1990. New lows appeared at hammers 3 and 4 as prices moved under the July lows at hammer 2. Yet, there was no continuation to the downside. The bears had their chance to run with the ball. They fumbled. The two bullish hammers (3 and 4) show the bulls regained control. Hammer 3 was not an ideal hammer since the lower shadow was not twice the height of the real body. This line did reflect, however, the failure of the bears to maintain new lows. The following week’s hammer reinforced the conclusion that a bottom reversal was likely to occur.
In this image (above) hammers 1 and 3 are bottoms. Hammer 2 signaled the end of the prior downtrend as the trend shifted from down to neutral. Hammer 4 did not work. This hammer line brings out an important point about hammers (or any of the other patterns I discuss). They should be viewed in the context of the prior price action. In this context, look at hammer 4. The day before this hammer, the market formed an extremely bearish candlestick line. It was a long, black day with a shaven head and a shaven bottom (that is, it opened on its high and closed on its low). This manifested strong downside momentum. Hammer 4 also punctured the old support level of January 24. Considering the aforementioned bearish factors, it would be prudent to wait for confirmation that the bulls were in charge again before acting on hammer 4. For example, a white candlestick which closed higher than the close of hammer 4 might have been viewed as a confirmation.
Drawing the intra-day chart using candlesticks shows the high, low, open, and close of the session (see image 4.11). For example, an hourly session would have a candlestick line that uses the opening and close for that hour in order to determine the real body. The high and low for that hour would be used for the upper and lower shadows. By looking closely at this chart, one can see that a hammer formed during the first hour on April 11. Like hammer 4 in image 4.10, prices gapped lower but the white candlestick which followed closed higher. This helped to confirm a bottom.
The second hourly line on April 12, although in the shape of a hammer, was not a true hammer. A hammer is a bottom reversal pattern. One of the criterion for a hammer is that there should be a downtrend (even a minor one) in order for the hammer to reverse that trend. This line is not a hanging man either since a hanging man should appear after an uptrend. In this case, if this line arose near the highs of the prior black candlestick session, it would have been considered a hanging man.
Image 4.12 shows a hammer in early April that successfully called the end of the major decline which had began months earlier. The long lower shadow, (many times the height of the real body) a small real body, and no upper shadow made this a classic hammer.
Image 4.13 shows a classic hanging-man pattern. New highs were made for the move via an opening gap on the hanging-man day. The market then gaps lower leaving all those new longs, who bought on the hanging man’s open or close, left “hanging” with a losing position.
In Image 4.14 we see that the rally, which began in early February, terminated with the arrival of two consecutive hanging-man lines. The importance of bearish confirmation after the hanging-man line is reflected in this chart. One method of bearish confirmation would be for the next day’s open to be under the hanging man’s real body. Note that after the appearance of the first hanging man, the market opened higher. However, after the second hanging man, when the market opened under the hanging man’s real body, the market backed off.
Image 4.15 illustrates that a black real body day, with a lower close after a hanging-man day, can be another method of bearish confirmation. Lines 1, 2, and 3 were a series of hanging-man lines. Lack of bearish confirmation after lines 1 and 2 meant the uptrend was still in force.
Observe hanging man 3. The black candlestick which followed provided the bearish confirmation of this hanging man line. Although the market opened about unchanged after hanging man 3, by the time of its close, just about anyone who bought on the opening or closing of hanging man 3 was “hanging” in a losing trade. (In this case, the selloff on the long black candlestick session was so severe that anyone who bought on the hanging-man day-not just those who bought on the open and close-were left stranded in a losing position.)
Image 4.16 shows an extraordinary advance in the orange juice market from late 1989 into early 1990. Observe where this rally stopped. It stopped at the hanging man made in the third week of 1990. This chart illustrates the point that a reversal pattern does not mean that prices will reverse.
A reversal indicator implies that the prior trend should end. That is exactly what happened here. After the appearance of the hanging-man reversal pattern, the prior uptrend ended with the new trend moving sideways.
Image 4.17 illustrates a classic hanging-man pattern in May. It shows a very small real body, no upper shadow, and a long lower shadow. The next day’s black real body confirmed this hanging man and indicated a time to vacate longs. (Note the bullish hammer in early April.)