Candlestick formations consisting of a single-session can be powerful signals of reversal that is just about to occur. The most popular among these are exceptionally long or exceptionally short candlesticks. Long white sessions or dojis (sessions with little or no real body) signal a bullish reversal at the end of a downtrend. And long black sessions or dojis signal a bearish reversal at the end of an uptrend. This “rule” is the basic observation of candlesticks. Any session that is exceptionally long or short compared to other sessions may signal reversal.
One pattern signals reversal depending on where it appears. This indicator has a relatively small real body (distance between opening and closing price), but its color does not matter. Both white and black sessions have equal value in this, the hammer or hanging man session. Besides the small real body, the pattern requires a longer than average lower shadow and no upper shadow. The shadow is the area of trading above or below the real body, and its exceptional length reveals that price moved during the session but retreated back into the narrow real body’s range.
When this pattern shows up at the bottom of a downtrend, it predicts a bullish reversal. This is when it is called a hammer. If it shows up at the top of an uptrend, it is bearish and then its name is hanging man. Some traders place more reliance on two-session or three-session candlestick formations, but don’t overlook the strength of one-session indicators like these, especially if they are confirmed by other signals forecasting the same reversal.
There are two main points about this that make it an unusually indicator. First, it is a single-session indicator, but even so it is a fairly strong reversal sign. Second, the color of the real body is not important; in candlesticks, the color of the real body is often among the most significant matters. A white real body results from the price closing higher than its open, and the opposite for a black real body. With hammer and hanging man, the color can be ignored.
Candlestick formations can reveal and foreshadow reversal, making the stronger ones such as hammer and hanging man valuable for entry and exit timing. Even so, any single indicator should be independently confirmed before you act. Confirmation can take place with candlesticks that follow the hammer or hanging man, by tests of resistance or support (especially if they fail, when reversal is most likely), or by volume spikes. Other methods of confirmation can be based on volume indicators or momentum oscillators like RSI.
The most important point to keep in mind is that trading and timing accuracy is invariably improved when any indicator is confirmed with a second, different one. Candlesticks are valuable for this, but they are only one of many technicals that offer great value.
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