In technical analysis you will come across chart patterns that help trends continue and they are called continuation patterns. Patterns that signal traders that the prices will reverse are called reversal patterns. In addition, there are bullish and bearish patterns that hint traders about the potential price direction. Head and Shoulders is one of the most commonly used reversal chart patterns. And no, we are not talking about your shampoo. Let’s find out what makes this pattern so popular.
Head and Shoulders definition
Head and Shoulders is a relatively easy-to-spot chart pattern that signals a trend reversal from bullish to bearish. When looking at the Head and Shoulders chart pattern traders will see that it consists of three peaks, all coming from the same baseline. For it to be considered Head and Shoulders, the second peak has to be the highest. The pattern is named after its shape that looks like a head and shoulders.
Why is Head and Shoulders important for traders?
- It is an easy-to-spot chart pattern, therefore every trader can easily use it.
- It shows a reversal from a bullish to a bearish market, so traders can make profits from short positions right from the start of a new trend.
- It appears on all timeframes, however, higher time frames have better likelihood of outcome.
- The Head and Shoulders pattern is considered to be one of the most reliable trend reversal patterns.
Thorough Head and Shoulders explanation
Head and Shoulders chart pattern is one of the most reliable trend reversal patterns out there. It consists of three peaks that have the same baseline. As it is common for three peaks to form on the Forex chart, it is only considered to be Head and Shoulders if the second peak is highest among the three.
The pattern is only considered complete when the necklace is broken, in other words, price breaches the support line. Trading an unfinished pattern is dangerous as the price might reverse and break the pattern formation. Which is why understanding Head and Shoulders in trading is important.
Example of Head and Shoulders in Forex
For better visualization, let’s look at the Head and Shoulders example in Forex trading. Be noted that pattern shapes on the chart may not be as perfectly formed as they are in the pattern sketches and schematics in trading books.
As you can see in this USD/JPY head and shoulder example, one shoulder is larger than the other but the pattern is obvious. In this example the pattern formed at the top of an uptrend and reversed the price direction. Keep in mind that in order to trade the pattern, you should always wait for the support breakout. In this case, traders had 2 perfect entries. The first entry point is when the price breaks out the support and the second entry opportunity is created by the price action when the price pulls back and tests the support from below. The failure to break the support is a strong sell signal. In this case, the support level becomes resistance.
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FAQs on Head and Shoulders in trading
What does Head and Shoulders mean in Forex?
Head and Shoulders is a trend reversal chart pattern that informs traders about an upcoming shift from a bullish market to a bearish one. It is an easy-to-sport pattern that can be used by both professional and novice traders.
Does Head and Shoulders work?
Yes. Head and Shoulders is a relatively accurate chart pattern and is utilized by a wide variety of technical traders. Keep in mind that in order to profit from the pattern, it’s important to open a trade after the support line is broken and not before.