How to trade Head and Shoulders Chart Pattern
We can spend all the time in the world talking about what it means to be a trader and how great it is, but you can only experience it through hard work.
There has been similar talks about mysterious shapes that are visible in charts everywhere. They are called chart patterns. It has been discussed double bottom and double top formations. Today we will talk about Head and Shoulders and Inverse Head and Shoulders. It sounds like a shampoo commercial, I know, but both, professionals and retail traders love it.
Head and Shoulders
One of the reasons this particular chart pattern is so popular is its reliability.
Just like double top and double bottom, head and shoulders is a reversal pattern. When the pattern is formed it signals that the security is likely to move against the previous trend.
Head and Shoulders and Inverse Head and Shoulders are also known as head and shoulders top and head and shoulders bottom, respectively.
Head and Shoulders Top and Bottom
Head and shoulders top forms during the peak of an uptrend. Once the pattern is formed it is a signal that the price will fall.
Head-and-shoulders bottom signals that the price will rise and usually forms during a downward trend.
Peaks and Troughs
The head and shoulders are sets of peaks and troughs. The level of support or resistance is known as the neckline. This pattern is based on Dow Theory that states that an uptrend is a period of repeated rising peaks and rising troughs while a downtrend is a period of falling peaks and falling troughs. When one of these trends weakens, head and shoulders come into play by providing you with the signal that there is deterioration in peaks and troughs.
Head and Shoulders Top
Before we can say anything please have a look at the image below. As we can see in the picture it looks like a formation of a human. Left shoulder, head and then the right shoulder. In fact with this explanation I’ve given you three out of four steps in the formation of this pattern.
1.It starts with the left shoulder, which is formed when the prices hit a new high and bounces of it to a new low.
2.Step two is the formation of the head. This happens when the price once again creates a new high but can’t stay there and comes back near the low of the left shoulder.
3.Step three is the formation of the right shoulder. This happens when the price once again forms a high, but this time it has to be lower than the one formed by the head and again comes back to the low formed by the left shoulder.
4.Since the same low, created by the left shoulder, was reached three times, we can safely say that this is the level of resistance, we also call it the neckline. To complete the pattern the price now needs to break the neckline (resistance) and signal the reversal of the trend.
Let’s simplify what we've just dicussed. This pattern is formed by a peak, left shoulder, followed by a higher peak, head, and another lower peak, right shoulder. Take note when drawing the neckline, you should connect the lowest points of the two troughs. The slope of this line can be either up or down. It doesn’t have to be perfectly straight line. There is a belief that down-sloping line is a more reliable signal.
Entry orders are often put under the neckline. For the profit target, the measurement between the neckline and the high point of the head is taken. This is approximately how much the price should move after it breaks the neckline.
Head and Shoulders Bottom
Head and shoulders bottom is the exact opposite of the head and shoulders head. It is formed during a downtrend to signal its reversal.
As we can see can see the steps to this formation are a trough, left shoulder, followed by a lower trough head, followed by a higher trough, right shoulder.
The entry order should be under the neckline and the profit target should be the same as the distance between the neck and the high point of the head.
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Very informative thread, but I have read only two names of Head and Shoulder, one is Head and Shoulder and other is inverted Head and Shoulder, Top and bottom Head and shoulder, first time I am reading, but anyways, it is true that the entry point should be at neckline, the picture you showed above is a simple head and shoulder pattern that can be identified easily, but sometimes we may see another small shoulder may be left or right, before confirming the head and shoulder, we also need to see whether the pattern is engulfing, forming or ending, so that we would be able to know about this matter, we also need to see if there is a double top or double bottom then what should we do, sometimes triple top or triple bottom happen, but traders don't know about it, because they only do their trades on short term, and this pattern need longer term trades.
Good thread. Tq to thread starter
This is a very informative post. It is good to understand this side of Forex Technical analysis.
Head and shoulders are good patterns of the chart and trading with it is interesting and profitable and many traders around the world trade with them and make money, they form more on the lower time frames than the higher time frames and when it forms it gives good chances for trading because they are strong patterns and give good results in most cases, the good trader knows how to determine the patterns on the different time frames and trade with them and the trader that does not know about them should read about them and try to find them on the chart and then he will trade better and he will get more profits and will like to trade with them always, the trader should always know all the other chart patterns.
It is true that if we are making use of the Head and shoulders pattern then we would be able to identify the Trends from reading the charts.
Originally Posted by Sameeh
We will need to understand how the charts are working before using them.
Originally Posted by Sameeh