The head and shoulders pattern is a classic technical analysis pattern that is often used to identify potential trend reversals in the financial markets. In this blog post, we’ll take a deep dive into the head and shoulders pattern, including what it is, how it is formed, and how to trade it.
What is the Head and Shoulders Pattern?
The head and shoulders pattern is a chart pattern that is formed when the price of an asset creates a series of higher highs and higher lows, followed by a lower high and a lower low. The pattern is named for its distinctive shape, which resembles a head and two shoulders.
The head and shoulders pattern is typically considered a bearish reversal pattern, as it is often seen at the top of an uptrend and signals a potential trend reversal to the downside. However, the pattern can also occur in downtrends and can signal a potential trend reversal to the upside.
How is the Head and Shoulders Pattern Formed?
The head and shoulders pattern is typically formed over a period of several weeks or months, as the price of the asset oscillates within a defined trading range. The pattern is characterized by three distinct price peaks, with the middle peak (the “head”) being the highest peak and the two outer peaks (the “shoulders”) being lower.
The pattern is typically completed when the price breaks through the “neckline,” which is the horizontal support level formed by the lows of the two shoulders. This break is known as a “neckline breakout” and is often seen as a strong signal of a trend reversal.
Trading the Head and Shoulders Pattern
If you are interested in trading the head and shoulders pattern, there are a few key steps you can follow:
- Identify the pattern: The first step in trading the head and shoulders pattern is to identify it on a chart. Look for the distinctive shape of the pattern, with the head being the highest peak and the shoulders being lower peaks on either side.
- Confirm the pattern: Once you have identified the head and shoulders pattern, it’s important to confirm that it is a valid pattern and not just a random fluctuation in the price. Look for other technical indicators, such as volume and trend lines, to confirm the pattern.
- Determine the neckline: The neckline is an important aspect of the head and shoulders pattern, as it represents the level at which the trend is likely to reverse. To determine the neckline, draw a horizontal line through the lows