Head and Shoulder Patterns in Trading
In this article, I am going to discuss the Head and Shoulder Patterns in Trading. Please read our previous article where we discussed Multiple Time Frame Analysis in detail. As part of this article, we are going to discuss the following pointers in detail which are related to the Head and Shoulder patterns in Trading.
- What is the head and shoulder pattern
- Types of head and shoulder patterns
- Failed head and shoulder pattern
- How to enter a head and shoulder pattern
Head and Shoulder Patterns:
The Head and Shoulders pattern signals a possible trend reversal from bullish to a bearish trend. And the opposite of it is called the Inverse Head and Shoulders pattern which signals a possible trend reversal from bearish to a bullish trend. It consists of four parts:
- The left shoulder
- The head
- The right shoulder
- The neckline
Here’s what I mean:
The market does pull back. At this point, there’s no way to tell if the market will reverse because a pullback occurs regularly in a trending market. The left shoulder moves up on big volume, retrace on lower volume
The market breaks and trades above the previous high. However, the sellers took control and drive the price lower towards the previous swing low (forming the Neckline). Higher high (head) on lower volume than left shoulder, then retrace that goes below the left shoulder.
The buyers make a final attempt to push the price higher, but it failed to even break above the previous high (the head). Then, the sellers take control and push the price towards the Neckline.
Then forms first lower high (right shoulder) on lower volume than the head. Sellers take control and drive the price down on more volume than the previous upswing volume not confirmed until breaks neckline.
This is the last line of defense for the buyers. If the price breaks below it with heavy volume, the market could head lower and begin the start of a downtrend.
Head and Shoulder Pattern Type
The Failed Head And Shoulders Pattern
Once prices have moved through the neckline and completed a head and shoulders pattern. Once the neckline has been broken on the downside, any close back above the neckline is a serious warning that the initial breakdown was probably a bad signal, and creates what is often called, for obvious reasons, a failed head and shoulders and prices resume their original trend
WHEN HEAD AND SHOULDER PATTERN FAILED
- The pattern appeared in a strong trend
- The duration of the pattern is small
Let me explain to you
1. The pattern appeared in a strong trend
The preceding trend is before the head and shoulders pattern. If the market is in a strong uptrend, it’s unlikely that a simple chart pattern can reverse the entire move.
2. The duration of the pattern is small
If the pattern takes a small time it is less likely to reverse a trend, it’s just a complex pullback. Here’s the thing: A Head and Shoulders that take more to form are MORE significant than a Head and Shoulders that take less to form.
Because if the market breaks the more time pattern Neckline, more traders will get “trapped” and their rush for exit will increase the selling pressure.
HOW TO ENTER A TRADE
For head and shoulder pattern entry condition
- The higher timeframe is in a downtrend
- The Head and Shoulders pattern formed at Resistance on the higher timeframe
- Volume confirmation
- The tight range at the neckline breaks out
- The breakout test of the neckline
- The first pullback
- Professional entry
1. The tight range at the neckline break out
PRICE drives down to the neckline and forms a tight range. enter when price breaks down from NECKLINE and place stop loss above the tight range.
2. The breakout test of the neckline
Often, the Head and Shoulder pattern may break down without forming a TIGHT RANGE.U MISSED THE OPPORTUNITY. If the market breaks down without forming a TIGHT RANGE, then wait for a pullback to occur. Price breakdown from the neckline and low volume test (PULLBACK) of the neckline is a high probability short opportunity
What you want to pay attention to is previous support (neckline) that could act as resistance. If the market comes into this area (neckline) and it gets rejected, this now is a favorable trade location to look for short trading setups. And your stops can just go above the neckline. So, here’s an example:
3. The first pullback
- If the market breaks down without forming a TIGHT RANGE, then wait for a pullback to occur
- If the market does a pullback(flag or tight range )with low volume and narrow range candle with upper wick, then go short on the break of the lows
- Set your stop loss above the highs of the pullback
So, this is what I mean by the first pullback, and here’s an example:
4. PROFESSIONAL ENTRY
- Wait for the market to form the Left Shoulder and Head
- After it’s formed, let the price rally higher back towards the Head with low volume and narrow candle
- Go short when you get a price rejection (like Shooting Star, Bearish Engulfing pattern, outside reversal bar)
Here’s an example: Ahead of the Crowd.
In the next article, I am going to discuss How to Trade with Support and Resistance in detail. Here, in this article, I try to explain the Head and Shoulder Patterns in Trading. I hope you enjoy this article. Please join my Telegram Channel and YouTube Channel as well as my Facebook Group to learn more and clear your doubts.
About the Author: Pranaya Rout
Pranaya Rout has published more than 3,000 articles in his 11-year career. Pranaya Rout has very good experience with Microsoft Technologies, Including C#, VB, ASP.NET MVC, ASP.NET Web API, EF, EF Core, ADO.NET, LINQ, SQL Server, MYSQL, Oracle, ASP.NET Core, Cloud Computing, Microservices, Design Patterns and still learning new technologies.