The Head and Shoulders pattern is one of the most powerful price reversal patterns in technical analysis. It can form on both an uptrend and a downtrend, in which case it is known as the Inverted Head and Shoulders pattern. As the name suggests, this pattern consists of two shoulders and a head that is higher than the shoulders.
Formation of the Head and Shoulders Pattern
On the chart, we see how the price reaches its peak, then retraces back to a level that becomes support after overcoming resistance (referred to in trading slang as the neckline), forming the first, left shoulder. The price then reverses and makes a new high, followed by another retracement to the support level. The final attempt to rise fails, as the price does not exceed the previous high, prompting bears to start selling aggressively, forming the right shoulder. The price breaks below the neckline, potentially testing it from the other side, and if it cannot break above it, the price begins to decline rapidly.
Head and Shoulders in Practical Trading
Target for the decline is determined by measuring the distance from the neckline to the peak of the pattern. Stop-loss should be placed safely above the peak of the right shoulder.
The Inverted Head and Shoulders pattern forms when a downtrend reverses into an uptrend. The rules described above apply in a mirrored fashion.
FAQ
What is the Head and Shoulders pattern?
The Head and Shoulders pattern is a common price reversal pattern used in technical analysis to identify potential trend changes.
How is the target calculated for the Head and Shoulders pattern?
The target for the decline is measured from the neckline to the peak of the pattern, providing a projection for where the price may move after the pattern completes.
Where should the stop-loss be placed for a Head and Shoulders trade?
A safe placement for the stop-loss is just above the peak of the right shoulder to protect against false breakouts.
