Trading on the hanging man and the hammer

To better illustrate the intricacies of the hanging man and the hammer, I show you examples of both patterns that were either confirmed the next day or not confirmed. If you're planning to dig into later chapters and read more about complex patterns, get used to the idea of confirming patterns, because it pops up continually throughout the rest of the book.

Going long with a hammer pattern

Figure 6-26 is a chart of Dell, Inc. (DELL) stock with a hammer that pops up during a downtrend. The following day, the stock opens higher than the close of the previous day for DELL. That's the confirmation that indicates that the hammer is a good long signal, and you'd be very wise to wait for it before buying. Be patient and wait for the confirmation, even if you're completely convinced that it's hammer time!

The confirmation may cost you a little in profits because you pay a slightly higher price, but Figure 6-27 shows what it may cost you if you choose not to wait.

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Figure 6-27 is also a chart of DELL. This one contains a potential buy hammer that isn't confirmed on the next day. In fact, the opening the next day is lower than the low that occurred on the day that the hammer appeared. Not only would you have saved yourself the effort of trading in and out of this stock by waiting for confirmation, but you'd also have saved yourself a little in losses.

If a candlestick signal calls for some sort of confirmation, always wait for the confirmation. Don't try to get ahead of the confirmation day by trading in early. In the long run, it catches up with you!

Figure 6-26:

A hammer with confirmation on a chart of DELL stock.

Figure 6-26:

A hammer with confirmation on a chart of DELL stock.

Figure 6-27:

A hammer with no confirmation on a chart of DELL stock.

Figure 6-27:

A hammer with no confirmation on a chart of DELL stock.

Shorting with a hanging man pattern

Now for a look at a successful hanging man. Figure 6-28 is a chart for the stock of Toll Brothers, symbol TOL. If you aren't familiar with Toll Brothers, it's a homebuilder focusing on the higher end of the housing market. If you remember what happened to the housing market in 2007, you can see why this is a good short example.

Figure 6-28 shows how you could have made money when the housing market first started to tank. I'm not saying that trading housing-related stock is the way to offset any potential losses in the value of your home, but this was a chance to take advantage of the fall in value of a home-building company as it anticipated the drop in housing prices and home sales activity.

Right at the very peak of a trend in the TOL stock, a hanging man appeared. If you happened to already own this stock (also called being long), that was a pretty scary signal that may have suggested that it was time to take your profits and move on to a less risky investment. If you were in the market looking for a stock to short, that would've looked like a swell opportunity. After the hanging man, a very dramatic reversal occurred, and the downtrend continued for several weeks.

Figure 6-28:

A hanging man short signal on TOL.

Figure 6-28:

A hanging man short signal on TOL.

Finally, I provide you with a hanging man that doesn't get confirmed. Sorry for the abundance of examples using retail stocks, but I've had a profitable history with them, and they often make good examples. Figure 6-29 is a chart of the stock for Kohl's Stores (KSS).

A very encouraging hanging man appears on the chart in a defined uptrend. However, after waiting patiently overnight for confirmation of the end of the uptrend and a shorting opportunity, a trader is surprised to see a gap opening and a continuation of the uptrend. If she's following the rules (as she should be) and waiting for the confirmation of the hanging man, all she gets is disappointment. But it could be worse: If she'd jumped the gun and sold, it would've cost her even more.

Figure 6-29:

A failing hanging man short signal on KSS.

Figure 6-29:

A failing hanging man short signal on KSS.

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