Head and Shoulders Pattern

The Head and Shoulders pattern is a widely used technical analysis tool that is effective in predicting trend reversals. It is particularly useful in identifying when an uptrend is about to end and a downtrend is about to begin.

The name of the pattern comes from its resemblance to the head and shoulders of a human figure when viewed on a chart. Initially, the price rises to form a peak (the left shoulder), followed by a slight pullback. Then, the price climbs to a higher peak (the head) before retreating again. Finally, the price rises to a third peak (the right shoulder), which is similar in height to the first peak.

In this article, you will find detailed insights into the Head and Shoulders pattern and how it can be used in trading strategies.

What is the Head and Shoulders Pattern?

The Head and Shoulders pattern is a chart model used in technical analysis to predict trend reversals. It typically indicates the end of an uptrend and the beginning of a downtrend.

The formation consists of three peaks: the first peak is referred to as the left shoulder, the middle peak forms the head, and the final peak is the right shoulder. The left and right shoulders are usually of similar height, while the head represents the highest point.

The pattern is completed when the support level, known as the neckline, is broken. This break is generally interpreted as a signal that the trend is about to reverse.

What is the Inverse Head and Shoulders?

In its simplest definition, the Inverse Head and Shoulders pattern is the reverse version of the Head and Shoulders pattern. It shows the end of a downtrend and the potential beginning of an uptrend.

The three troughs that together make up the pattern are the head, the left shoulder, and the right shoulder. The first trough is called the left shoulder. The head is the lowest position, while the left and right shoulders are usually around equal depth.

When the neckline breaks to the upside in this type of pattern, the breakout occurs. There should be an upward rise next to the breakthrough.

How Do You Identify a Head and Shoulders Pattern?

To identify a Head and Shoulders pattern, you can follow these steps:

• First, prices rise for a certain period and then form a peak followed by a slight pullback. This is where the left shoulder appears.
• Prices rise again, creating a higher peak above the previous one, forming the head of the pattern.
• Then, prices pull back again, approaching the previous low.
• Prices rise once more but form a peak below the previous one (the head), creating the right shoulder.
• The lows of the left and right shoulders are connected to form a neckline, representing a support level.
• The pattern is considered complete when prices break below the neckline.

How to Trade the Head and Shoulders Pattern?

Here are the steps you can follow to trade using the Head and Shoulders pattern:

• Wait for the clear formation of the left shoulder, head, and right shoulder.
• Identify the neckline and carefully observe the points where the price approaches the neckline. You can anticipate a trend reversal when the neckline is broken.
• After the breakout, you can aim to profit by taking a short position. You may also find a better entry point by waiting for a pullback in the price.
• Determine the target price by measuring the distance between the highest point of the head and the neckline, then subtracting that distance from the neckline.

Example of the Head and Shoulders Pattern

The Head and Shoulders pattern consists of three phases. First, let's try to understand these phases in the chart below:

• Left Shoulder (Beginning): We see that prices rise for a certain period and then form a peak before experiencing a slight pullback. This first marked area on the chart forms the left shoulder of the pattern.
• Head: Afterward, prices rise again, surpassing the previous peak and creating a higher peak. The higher peak is known as the head.
• Right Shoulder: Prices start to rise again but this time fail to reach the level of the previous peak (the head), forming a lower peak. The third peak forms the right shoulder.

At this point, we can draw a neckline by connecting the low points of the left and right shoulders. The line, which is usually horizontal or slightly inclined, represents the support level of the pattern.

Advantages of the Head and Shoulders Pattern

• Provides a reliable signal, especially for predicting trend reversals. It indicates the end of an uptrend and the beginning of a downtrend.
• The formation offers clearly defined entry and exit levels, helping traders make strategic decisions.
• The pattern can be effectively used in various markets, including Forex, stocks, and commodities.
• It allows traders to capitalize on significant market movements.

Pitfalls of the Head and Shoulders

• False breakouts can occur, leading traders to take incorrect positions.
• The formation can take time to complete, and during this period, other market factors may affect its validity.
• Breakouts occurring with low volume can reduce the reliability of the pattern.
• It does not always yield effective results in different market conditions.
• It can be misleading if not supported by other technical analysis tools.
• The neckline can sometimes be slanted, making accurate assessment more difficult.

FAQs About Head and Shoulders Graphic Pattern

What does the Head and Shoulders pattern tell you?

The Head and Shoulders pattern typically indicates that an uptrend is coming to an end and a downtrend may be starting. In other words, it signals that market participants' confidence in a particular asset is waning, and sellers are becoming more dominant.

Can the Head and Shoulders turn bullish?

The Head and Shoulders pattern is typically considered a bearish signal, but the Inverse Head and Shoulders pattern indicates the beginning of an uptrend. In this case, the pattern is considered bullish.

What happens after a head and shoulders pattern?

After the Head and Shoulders pattern is completed, a downtrend usually begins. Prices continue downward after breaking below the neckline, signaling investors to open short positions.

Can a head and shoulders pattern fail?

Yes, the Head and Shoulders pattern can fail. If there are false breakouts or the pattern is not fully completed, the expected price movement may not occur.

Is the Head and Shoulders pattern reliable in Forex?

The Head and Shoulders pattern is widely used in the forex market and is generally considered reliable. However, it is important to validate the pattern with other technical indicators to increase its effectiveness.

How do you draw the neckline in a Head and Shoulders pattern?

The neckline is drawn by connecting the lows of the left and right shoulders. It is usually horizontal or slightly sloped and represents the support level that prices are expected to break once the pattern is complete.