Identifying recurring patterns may significantly increase chances for successful trading. The patterns differ in terms of reliability. Head and shoulders pattern is one that is considered to be a very strong one. It belongs to the group of reversal patterns.
Head and shoulders pattern description
The pattern owes its name to the shape it forms on the price chart. It reminds of the head and shoulders as there is one high peak in the middle, and two smaller ones around it.
At the top of the uptrend, the bulls are in control. But the bears come in and draw the price down. The bulls, however, do not quit so easily, and so the price rises even higher. The fight between bulls and bears continues. The third peak is created, although not as high as the previous one.
During the downtrend, the pattern is called reversed head and shoulders. The price is falling, then rises a bit creating the first shoulder. After that, the price is falling even more and rises again after a while. The head is formed. Next, the price falls a little bit just to reverse again and go upwards. This is the second shoulder of the pattern.
Head and shoulders is a reversal pattern which means it signals the change in the direction of the price in the market.
Head and shoulders reliability
The head and shoulders pattern represents the strong fight between the bulls and the bears. They pull the market up and down and so we can see how the price is subsequently rising and falling.
Because this fight is very strong, it is also time-consuming. You may need some portion of patience to wait for the pattern to form. And it is important to wait until it is fully developed. If you rush things and get down to the action before that, you will probably lose money. The market can unexpectedly change its course and move against you. Nevertheless, if you wait until it is fully created, you will be surely rewarded.
It takes much longer for the head and shoulders pattern to be created than, for example, double tops formation, which is also a pattern from a group of reversal ones.
Good news is that such a long formation time influences its credibility. It produces more reliable signals than the double tops mentioned above.
Where to look for the head and shoulders?
It always appears at the end of the trend. And by the end, I mean the highest top or lowest bottom. In case you see a similar composition that occurs without the previously existing trend, it will be not our pattern. In the end, you will discover it was not exactly same as the head and shoulders.
You look for the head and shoulders always at the peak of the trend. It will be the top during the uptrend or the bottom throughout the downtrend. In the latter scenario, it is also called the reversed head and shoulders pattern.
Using the head and shoulders at Olymp Trade for opening long positions
Below, you will find an exemplary chart for the NZDUSD currency pair. There is a clear uptrend. At some point, the price starts to fall but rises even higher afterwards. We have the first shoulder of the pattern. When the price falls the second time, the head is created. Finally, the price is again rising, though not as high as at the second time, and then begins the downtrend. The second shoulder is built and at the same time, the whole pattern has emerged.
How to use this pattern in trading? When exactly enter the trade? The keyword here is patience. I know, you were waiting already long enough for a full pattern to form. But the last thing you have to do is to wait a little bit more.
The best entry point is when the price crosses the neckline. The neckline of the head and shoulders formation is the trendline that is drawn by joining all the lows in the pattern.
Sometimes, the price is testing this trendline. It nears it, even touches the line, but do not cross it. You must wait for the moment when the price breaks the neckline. You enter the trade when the first candle closes beneath this line.
Using the head and shoulders at Olymp Trade for opening short positions
Below, you have the chart for the AUDCAD currency pair. This time, there is the downtrend. You are looking for the reversed head and shoulders pattern. Observe, how the price is falling and then rising. Then falling more and rising again. After that, it falls just a little bit and eventually breaks the neckline of the head and shoulders pattern.
The neckline in the reversed head and shoulders formation is created by connecting the highs in the pattern.
Wait for the price to break the neckline. When the first candle finishes over it, this is the right moment to enter a sell position.
The head and shoulders pattern is a very reliable reversal pattern. This means that it signals the change in the direction of the trend. Moreover, it gives you a pretty high chance of accuracy. Just remember to wait for the pattern to fully develop.
The pattern is even more valuable when the shape of the head and shoulders is more symmetrical.
During the uptrend, the pattern forecasts a change to the downtrend. You may expect the price to fall to the height of the head.
The same applies to the downtrend. Just, in this case, the price supposedly rises as far as the length of the head in the formation.
I recommend practising to recognise and use the head and shoulders pattern on the demo account. Olymp Trade offers it free of charge and it is credited with virtual cash.
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