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What is the head and shoulders chart pattern?
As a component of technical analysis, the head and shoulders chart pattern is a special chart. The chart represents potential bearish or bullish trend reversals with varying degrees of accuracy and is considered one of the most reliable trend reversal patterns available today.
The pattern works on full time frames, which makes it often present in the trading strategies of investors, day traders and swing traders. The features of the head-and-shoulders chart, such as price targets, entry and exit levels, are simple to operate and informative, and are loved by both novice traders and experienced experts.
The name Head and shoulders chart shape comes from the visual feature of the chart, which looks like the shape of the head and two shoulders. In fact, there are two types of head and shoulder charts. First, let's look at what the head and shoulders chart patterns include:
Each head and shoulders chart pattern includes:
- Left shoulder
- Head
- Right shoulder
- Neck line (pullback line)
When creating a chart, it is generally drawn from the left shoulder. Subsequently, the price action forms the head, which may be above or below the left shoulder, depending on the type of chart pattern. This is followed by the right shoulder, usually at roughly the same level as the left shoulder. The neckline is added when the chart is drawn and can be a horizontal line or a lifting line.
It is important to note that it is rare to draw a perfect head and shoulders chart. Because some possible price interference in the drawing process will affect the drawing effect, the shape of the head and shoulder may not be obvious, and the position level of the two shoulders may not be on the same line.
Also, be careful not to confuse the reverse mode with the continuation mode. Generally, the price fluctuations in the head-and-shoulders reversal pattern are not less than the price fluctuations in the previous trend. If the head and shoulders pattern is very small compared to the price wave around it, it may be a head and shoulders finishing pattern.
Head and shoulder top mode
The general Head and Shoulders pattern is at the Top of the uptrend and is known as the "Head and Shoulders Top" (Head and Shoulders Top), which is a bearish pattern.
The left shoulder is formed at the end of the rally. After its peak is formed, asset prices will fall to some extent as a subsequent reaction. The head is formed when the price rises again, and the highest vertex of the chart appears. Then came another price drop. The right shoulder forms when the price rises again, but remains below the head. The price then falls to the position of the first trough between the left shoulder and the head, or at least below the apex of the left shoulder.
Finally draw a neckline through the bottom of the head and both shoulders as a support line. When the price breaks through the neckline after the formation of the right shoulder and continues to decline, it indicates that the head and shoulder top pattern has been completed.
Head and Shoulder Bottom Mode
Head and Shoulders patterns can also be drawn in the opposite direction, called "Head and Shoulders Bottom" (Head and Shoulders Bottom) or "Inverted Head and Shoulders" (Inverted Head and Shoulders). The head and shoulder bottom pattern is the rising pattern and is at the bottom of the downtrend. This pattern indicates that the current bearish trend may reverse and prices will move higher.
After the formation of the left shoulder, the price completed the first rise. The price then falls to a new low, followed by a rebound to the original position to form a head. After the adjustment, the price fell to form a right shoulder, and then rose sharply again. At this point a neckline is drawn as a resistance line. Once the second shoulder is formed, the price will have a final rally and break the neckline, which means that the head and shoulder bottom pattern is completed and the downtrend is reversed.
Another difference between the top of the head and shoulders and the bottom of the head and shoulders is that the former usually forms within a few weeks, while the latter takes months or even a year.
How to interpret the head and shoulders form?
When studying the head-shoulder-top pattern, measuring the vertical distance from the head Peak to the neckline helps to determine the approximate size of the spread. Let's take an example, when the vertical distance is $10, once the neckline is breached, technical analysts can predict that the price will fall by at least $10. And the opposite is true for the head and shoulder base mode: Measuring the vertical distance from the head Peak to the neckline gives you a rough idea of how far the price may exceed the neckline.
What is the role of the head and shoulders form?
The head and shoulders pattern is a very effective technical analysis tool for measuring and evaluating the minimum distance that the price may move from the neckline in the future. At the same time, traders can also use it to judge the trend of large reversals between bull and bear markets. The head-shoulder pattern is one of the most reliable tools for reverse trend prediction.
In the long run, it is beneficial to understand how to trade on the basis of different head and shoulder patterns. Adding a head and shoulders pattern to the overall trading strategy can be considered an important and classic trading technique.
Head and Shoulder Shape Use Guide
Before making any trades, make sure the head and shoulders form is fully formed. Don't act too hastily until the right shoulder is fully formed, assuming that the head and shoulders form will be completed and trading ahead of time may cause unnecessary losses. The market is volatile and prices are always changing rapidly.
Partially completed and soon-to-be-completed charts deserve careful observation, but no trading operations should be carried out until the price breaks the neckline. Wait patiently and prepare a trading plan in advance, including entry price, take profit and stop loss target, etc. Everything is ready, just wait for the neck line to be broken, you can take advantage of the characteristics of the head and shoulders shape to place an order.
When trading using the head and shoulders pattern, the price is expected to fall below the neckline. It is suitable to open a short position when the head and shoulder top pattern is completed and the price falls below the neckline and continues downward. Measuring the distance from the head Peak to the neckline can calculate the trading profit target.
The inverted head and shoulders pattern trades the same way. At the completion of the head and shoulders pattern, the price breaks through the neckline upward, at which point it is appropriate to start taking long positions. The profit target can be derived by calculating the distance between the price high and the price low.
In both cases, you can settle your exit when the price is close to the target price; Or take a position to make more profit when the price continues to rise/fall, until the next inversion signal appears.
The key to mastering the head and shoulders form is to wait patiently for the pattern to form, because sometimes artifacts may appear. Also, don't forget to set a stop-loss price. When using the head-shoulder mode, the stop-loss point is usually always above the right shoulder peak or the head peak, while the stop-loss point in the head-shoulder bottom mode is usually always below the head price low.