“Head and shoulders” is a pattern of technical analysis, which is rarely found on the price trend chart, but always becomes an object of interest to novice traders. What does the appearance of this pattern indicate?

What is a “Head and Shoulders” figure?

These are three waves of different heights on the chart, which appear after an intense bullish trend, i.e. growth in asset value. The appearance of this figure indicates the end of the current movement, when traders should prepare for the formation of the reverse trend direction. Thus, the GS is a reversal pattern.

The model can be formed during a long decline in the trend in a bear market. Then you are facing an “Inverted Head and Shoulders”. The larger the timeframe on which the pattern was formed, the higher its significance.

What does the Head and Shoulders figure consist of?

The correct figure is formed by three elements: a high head and two shoulders at the sides, one of which is ideally slightly lower than the other. The lower levels between the peaks of the figure create a caliper level called the neck and sometimes the neckline.

 

If the trader has a feeling that the price tried to reach a new high, but the buyers did not have the “mood” to continue the uptrend, it is time to analyze the emerging pattern.

 

How is the Head and Shoulders technical analysis performed?

A dominant bullish trend on the chart is mandatory, because the Head and Shoulders reversal pattern is analyzed. Technical analysis is carried out on a specific time interval. It is necessary to mark the upper and lower lines of price movement on the chart. Usually the support level is the neck of the figure.

When the “head and shoulders” figure is formed on the price movement chart, the trader needs to identify the trading volume. For this purpose, a technical indicator is used, or the volume is taken in its pure form. Rise at the top of the first wave is replaced by long candles of decline. At the peak of the second wave, the trading volume will be lower than at the top of the first wave. The peak of the third wave will be lower than that of the first wave, and the trading volume will be lower than that of the second wave.

Another factor in technical analysis is the price, or more specifically, the target price after passing through the three peaks of the pattern.

Target price = Neck – (Head Peak – Neck Peak).

The obtained result should be considered as an assumption, which can be confirmed or refuted by Fibonacci lines or long moving averages.

The Head and Shoulders pattern is fully formed when the price level breaks through the neckline of the pattern. The support level becomes the resistance level.

 

 

How to apply the “Head and Shoulders” figure in trading?

The trader has several options for opening a deal to sell assets on the GP figure.

When the third wave is formed, but the price has not yet crossed the neckline. This is a risky method, but if successful, it will bring the greatest profit.
As soon as the candle breaks the neckline level. This is a classic entry with a good prospect, however when used the trader still has no confirmation of the pattern.
When the trendline tries to reach the neckline again, but at the resistance level. This is the optimal option, although the trader has the risk of missing the entry point.

Setting stop orders is also carried out in several ways.

Above the level of the final correction. If the price goes further up, the trader is expected to suffer minor losses. But there is a risk of exiting the trade earlier than necessary.
Above the notch. A stop order will automatically close the trade if the price crosses the neckline level from the bottom to the top. This will mean that the GP model has not formed, and it is not worth trading on it.

Withdrawing the maximum profit is the most difficult part of the trade.

Conservative traders take profit at the nearest support line. It should be marked on the chart segment with the highest probability of price rebound. The main thing is not to set the level too close, otherwise the profit will be less.
You can count the number of pips from the cut line to the top of the second wave. Postpone a similar number of pips down from the breakout point. Set an order to withdraw profit at the nearest support level.

Conclusions

The classic reversal signal in the bull market is a “Head and Shoulders” pattern. Trading in real conditions has shown that the true pattern is formed quite rarely, and it is often confused with pseudo-patterns. However, if the pattern does form, it provides confidence in the consequences. The pattern solves the main tasks of successful trading: not to go against the market trend, to fix changes in the moods of bears and bulls, to get the maximum profit.