Generating Trading Signals Based on Candlestick Patterns

Hammer and Hanging Man (Inverted Hammer)

A candlestick chart pattern is called a hammer if it has a long shadow and a small body (black or white) that is very close to the high of the day. At the end of a downtrend, the hammer is considered a bullish reversal signal (see Figure 4.23).

The hammer often shows up at the end of a downtrend. After we identify a hammer, we buy next day at the high of the previous day. The stop-loss is below the low of the previous day.

The corresponding candlestick chart pattern of a hanging man is a hammer at the end of an uptrend. We sell on the occurrence of this chart pattern if the low of the day with the hanging man is broken. The stop-loss in this case is the high of the day at which the hanging man pattern has occurred.

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