Today’s Japanese candlestick pattern is called the “Hanging Man”. It is a reversal pattern that is often found at the peak of an upward trend.
A hanging man must be found during an up trend in order to be meaningful. A hanging man is defined by a small real body, long lower wick, and short or nonexistent upper wick. The more defined these characteristics, the stronger the signal. As a general rule, the lower wick should be about twice as long as the body or longer. The hanging man also needs a confirmation signal, which is given if the next trading day closes below the real body of the hanging man candle. Volume is also very important for the hanging man. High volume on the hanging man day means that traders who bought that day will be stuck with losing trades if the signal is confirmed the next day. Your stop loss in this case can be set at the open or high of the hanging man. Therefore, the difference between the stop loss and the opening price of the trade is the possible loss. If you are not comfortable with this loss then you must either adjust your trades’ size or wait for a retrace that may or may not occur.
Here is a chart which belongs to UNG (United States Natural Gas Fund).
Can you spot the hanging man and the confirmation? What is the stop loss?
Hanging man picture is credited to Steve Nison, author of Japanese Candlestick Charting Techniques 2nd Ed.