Candlestick formations can help you understand what the market is doing before most other indicators. For swing traders and traders of high / low options, the hammer and the hanging man are two of the most helpful formations.
What are the hammer and the hanging man?
Both the hammer and the hanging man have a small body, a long lower wick, and no upper wick. The hammer is an upwards candlestick. The hanging man can be an upwards or a downwards candlestick. In most cases, however, the hanging man is a downwards candlestick.
The difference between the hammer and the hanging man comes from the place where they occur in a price movement:
The hammer occurs after a downwards movement, the hanging man after an upwards movement. In general, the more consecutively falling (hammer) or rising (hanging man) periods preceded the signal, the more significant the signal is.
You might see candlesticks that look like a hammer or a hanging man in many situations. To qualify as a hammer, however, they have to occur after a number of consecutively falling periods. To qualify as a hanging man, they have to occur after a number of consecutively rising periods. Any candlestick that looks like a hammer or a hanging man that occurs in any other place is not a hanging man / hammer.
The psychology behind the candlesticks
The hammer and the hanging man are sometimes called “reversal candlesticks”. To understand why, let us take a look at the psychology behind both candlesticks. The hammer occurs after a number of consecutively falling candlesticks. The long lower wick of the hammer signals that prices first started to fall in this period, too.
After some time, however, the market did not have enough momentum to push prices any lower. Instead, the market turned around and closed the period over its opening price. This event is significant, as it indicates a fundamental change in market sentiment: The bears have lost power, and the bulls have taken over. Therefore, you can expect the next periods to feature rising prices, too.
The hanging man occurs in a similar situation: After a number of periods that featured rising prices the market fell right after the opening price and never fully recovered. This means, the bulls have run out of power, and the bears are now controlling the market. Therefore, you can expect the market to continue to fall for the next periods.
How to trade the hammer and the hanging man
Depending on the time frame of your chart, you might be able to trade the hammer and the hanging man with a high / low binary option with a very short expiration time. For this kind of strategy you should use an expiration time similar to the time frame of your chart. If you are working from a 15 minute chart, for example, you could invest in a high / low option in direction of the hammer / hanging man with an expiration time of 15 minutes. Similarly, in a 30 minute chart you should use an expiration time of 30 minutes.
If your binary options broker offers you a touch option with a realistic target price in direction of the hammer / hanging man, you can invest in this option, too. You can use your experience or technical indicators such as the average true range to determine what a realistic target price is.
Swing traders, on the other hand, can use the hammer and the hanging man to determine the ending of one swing and the beginning of another. When a hammer / hanging man occurs near a trend line, a support / resistance level, or any other market element that makes an impending turnaround in market direction likely, you can use the hammer / hanging man to invest in this movement very early, and therefore secure the best conditions to win a high / low or a touch option.