The Head and Shoulders Pattern is a trend reversal pattern consisting of three peaks. The two outside peaks are in the same height, while the middle one is the highest. The pattern identifies a bullish to a bearish trend reversal and emerges in an uptrend. To detect a true head-and-shoulders trend reversal, it helps to understand how they’re created: The left shoulder forms when traders pushing a currency pair higher temporarily lose enthusiasm. The head forms when enthusiasm peaks and then declines to a point at or near the currency pair’s previous low.
What is the Head and Shoulders Candlestick Pattern?
The formation of the pattern is based on a peak (shoulder), followed by a higher peak (head), and then another peak (shoulder). The two shoulders symbolize right and left shoulder. A neckline can be drawn by joining the lowest points of the two troughs (a stage which tells the prices are declining before rising again).
The Head and Shoulders describes that the price hurries its way to the top but then declines. After that, the price rises again but is higher than the previous level, then drops back. Finally, the price climbs up again but equal to the first peak’s level and then declines back.
Here’s what the Head and Shoulders Candlestick Pattern looks like on a chart:
The opposite of the Head and Shoulders Pattern is the Inverse Head and Shoulders. It appears in a downtrend and signals a reversal from the bearish pattern to a bullish pattern.
Sometimes when the Head and Shoulders Pattern is present, the price breaks through the resistance level, indicating a bearish pattern, it is known as a double top. It finds its way in an uptrend and breaks a neckline formed by the Head and Shoulders Pattern. This tells us that a trend reversal is near. The Double Top looks similar to the alphabet M.
How to use the Head and Shoulders Candlestick Pattern?
It is pertinent to wait for the Head and Shoulders Pattern to complete its construction. This is because a partially developed pattern may not complete in time.
An entry is usually considered when the pattern breaks the neckline (level of support and resistance, determining areas of placing orders).
A short trade is made right after a formation of the right shoulder. The stops can be placed above the right shoulder. Alternatively, the head can be used as stops.
The Head and Shoulders Pattern has a few limitations. It doesn’t give a clear picture about the bullish or the bearish trend. When one peaks forms, the price declines. But then, the bulls push the price up again, forming a middle peak before the bears retake control. Bulls push the price one more time, creating a new peak, but afterward, the bears take over, completing the reversal.
These highs and lows are confusing for some traders, and sometimes there is a significant drop in price on one of the shoulders. Besides this, the Head and Shoulders Pattern can take a long time for its appearance.
Head and Shoulders Candlestick Pattern trading strategy
In terms of technical analysis, the head and shoulders pattern is a predicting chart formation that usually indicates a reversal in the trend where the market makes a shift from bullish to bearish, or vice-versa. This pattern has long been hailed as a reliable pattern that predicts trend reversal.
The Head and Shoulders Pattern can be spotted on all timeframes and be used for entry, exit, and stop-loss if implemented within a forex trading strategy.
However, I find it works better when combined with other technical analysis, fundamental analysis and sentiment analysis.
As the candlestick pattern is a transformation of bullish to bearish, it only provides sell signals. They can appear on forex currency pairs, stocks, indices, cryptocurrencies, commodities, metals, energies, gold, silver and more.
In the head and shoulders pattern, we are waiting for price action to move lower than the neckline after the peak of the right shoulder. For the inverse head and shoulders, we wait for price movement above the neckline after the right shoulder is formed. A trade can be initiated when the pattern completes.
Head and Shoulders sell strategy
- Wait for the completion of the pattern.
- Wait for the price bar to go bearish before entering.
- Enter after the formation of the right shoulder.
- Place a stop-loss near the high from the right shoulder.
- Exit the trade when the price rises.
Head and Shoulders Candlestick Pattern conclusion
The head and shoulders chart is said to depict a bullish-to-bearish trend reversal and signals that an upward trend is nearing its end. Forex traders consider it to be one of the most reliable trend reversal patterns. The primary theory behind harmonic patterns is based on price/time movements which adhere to Fibonacci ratio relationships and its symmetry in markets. Fibonacci ratio analysis works well with any market and on any timeframe chart.
The Head and Shoulders Candlestick Pattern can be used on your trading platform charts to help filter potential trading signals as part of an overall trading strategy. The Head and Shoulder Pattern illustrates the movement of the price and can help to spot potential reversal trades. Yet, the pattern has some drawbacks. Therefore, when trading the pattern, it can be used with other technical indicators.
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