Trading head and shoulders is very popular among those using technical analysis. Today we take it apart and show you how to do it properly.
Trading with repeatable patterns can be a good way to make a profit you desire. Some patterns are more reliable than the others, though. Today, I will present to you a reversal pattern that belongs to the first group. It is called the head and shoulders pattern.
What is a head and shoulders pattern?
The head and shoulders pattern is a very strong formation and it takes much more time for it to complete in comparison to other patterns. The long time of creating is caused by the fact that it appears at the peak of the upward movement. So when the bulls have control over the market you may start looking for the head and shoulders pattern. The advantage of such a long creation time is that the formation is very reliable. Its accuracy is greater than other reversal patterns like double tops formation. It follows that trading head and shoulders patterns can prove lucrative.
Sometimes you may get tired of waiting for a pattern to complete. Remember, do not trade until it is finished. Otherwise, you may lose money as the situation on the market may change at any second and the pattern may eventually not appear. But once it is there, once it is finished, you get nearly 100% certainty of the next price movements.
Is the head and shoulders pattern always at the top?
Yes and no. The head and shoulders pattern develops always at the top of the trend. If you spot a similar formation in the middle of the trend or within a range, it is not the pattern you are looking for. It may look like the head and shoulders at the beginning, but later you will see it is not the same. So you search for it only at the top.
But it can be the peak of the uptrend and the downtrend as well. This way it can be the top or the bottom. If it appears during the downtrend, it is called a reversed head and shoulders pattern. The most important thing is that it develops at the highest/lowest point of the trend.
How to identify the head and shoulders pattern on charts?
The shape reminds of the head and shoulders, thus a name. Let's consider the uptrend. At the top point there is a rise in the price and then a fall. After that, the price rises again, higher than the previous peak just to fall again. This is the head. Then, the price rises for the third time, but not as high as the second time, and it falls afterwards. The first and the last rises are the shoulders, the middle one is the head. One peak and two lower highs, this is a shape of the head and shoulders formation.
In the downtrend the situation will look very much similar, only reversed. First, the price will fall to the new low and then rise a bit creating a shoulder. Then, it will fall more and rise again, and we will get the head. After that, the price will fall, but not as low as the second time and next, it will start to rise. The second shoulder is created.
There are three attempts made by bulls (or bears, depending on the direction of the trend) to carry the price higher (or lower) and create new peaks. This is why it takes such a long time for this pattern to develop, but this is also why it is so reliable. If you only have the patience to wait until the bears (or bulls) will take the market over, you may gain significant profit.
How to use the head and shoulders pattern on IQ Option
Let's take a look at the example below. Find the uptrend and notice how the price is moving. It rises to a new peak and then falls. Next, it rises to a higher peak and declines afterwards. Finally, it rises to a lower high and falls again. Three subsequent rises and falls. The shoulder, the head and the second shoulder. Our pattern is developed.
Now the main question is how to trade with the head and shoulders pattern. All you have to do is wait. Yes, patience is crucial not only in private life but in trading as well. You were waiting for the pattern to create for a time and what you are waiting for now, is the moment where the price breaks the neckline. And what is the neckline? It is the trendline that connects all three lows of the formation.
Be careful, as the price may test the neckline. It may come close, touch it but not go beyond. Again, be patient. You are waiting for the point where the price breaks through the neckline.
Your entry point is where the first candle closes below the neckline. Once it is done, you open a sell position.
The next example shows the reversed head and shoulders pattern that develops at the bottom of the downtrend. Look how the price falls and rises, then falls more and rises again and at last, falls only a little just to rise above the neckline.
In this case, the neckline joins all the highs of the formation. You should open a buy transaction when the first candle closes above the neckline.
Final words on the trading head and shoulders pattern
The remarkable thing is that the price tends to fall (or rise) as far as the height of the head in the pattern.
The other thing is that the more symmetrical shape, the more valuable the pattern.
The last thing is that the head and shoulders pattern is a reversal pattern which means you may be pretty sure the trend will reverse. This gives you an excellent opportunity to make some money.
Wish you enjoyable trading!
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