The Hanging Man signal is found at the top of an uptrend.
In order for the Hanging Man signal to be valid, the following conditions must exist:
The stock must have been in a definite uptrend before this signal occurs. This can be visually seen on the chart.
The lower shadow must be at least twice the size of the body.
The day after the Hanging Man is formed, one should witness continued selling.
There should be no upper shadow or a very small upper shadow. The colour of the body does not matter, but a black body would be more positive than a white body.
The following Figure shows a Hanging Man formation. Similar to the Inverted Hammer, the Hanging Man signal is counter-intuitive. Just by looking at this candle formation, one can say that the bulls held their dominance..that they defended themselves against the bears. However candles should always be considered as part of the overall picture. In an uptrend, when the candles were long and white, the bulls were not challenged at all. they had a easy run. Now the bulls have to fight for every cent. They are tired after the uptrend. In this situation, if the bears can force the stock to close down on the day after the Hanging Man, the bulls will be more apt to lock in profits. This will give more room for the downside reversal.
Following chart shows a Hanging Man formation in AMLN. This signal was followed by a gap down the next day. Somebody wanted to get out in a hurry! On top of that, the stochastics were overbought and the Hanging Man was confirming a double top, with the resistance from late March. The market was very clearly telling investors to get out then. Remember, these candlestick signals have been tested for almost 400 years. They would not have been in existence if they wouldn't have worked.
Chart courtesy stockcharts.com
The chart below for OMAXE Limited (OMAXE) depicts a Hanging Man after a Bearish Engulfing signal. When one candlestick reversal signal is followed by another reversal signal at the same level, the probability of trend reversal is very high. A short position established after confirmation of the Hanging Man would have led to excellent profits for the short side trader.
Chart courtesy icharts.in