How To Trade Head and Shoulder Pattern

In the world of technical analysis, certain chart patterns hold the key to predicting market trends and potential reversals. Among these, the head and shoulder pattern stands out as a powerful indicator of trend shifts.

If you’re an aspiring trader looking to enhance your analytical skills and capitalize on market opportunities, understanding and effectively trading the head and shoulders pattern is an essential skill to acquire. This article delves into the intricacies of this pattern, breaking down its components, signaling characteristics, and providing insights into crafting successful trading strategies.

Whether you’re a novice or a seasoned trader, mastering the art of recognizing and trading the head and shoulders pattern can elevate your trading game to new heights.

What is a trading pattern?

A trading pattern is a well-defined and identifiable price movement or pattern on a financial chart. Traders use a trading pattern to make decisions about buying or selling an asset, such as a stock, currency, or commodity. 

Trading patterns are used by traders to predict future price changes and to find probable entry and exit locations for their transactions. Additionally, traders use trading patterns to control risk.

Some of the most common types of trading patterns are:

• Head and shoulders
• Double top
• Cup and handle

And many more

Join Coincodecap Signals to level up your trading game with automated trading and accurate trading signals with proper explanation.

What is the Head and Shoulder pattern?

• The “head and shoulders” pattern is among the most commonly used technical analysis patterns in the financial markets, particularly in chart analysis and crypto trading. The head and shoulders pattern, often referred to as a trend reversal pattern, is used to predict the probability of a trend reversal in the value of an asset, such as a crypto token or a foreign currency pair.

• The head and shoulders pattern consists of three peaks or valleys in a price chart, which resemble the shape of a person’s head and shoulders. There are two variations of this pattern: the “head and shoulders top” and the “head and shoulders bottom,” depending on whether it appears at the end of an uptrend or a downtrend.

Head and Shoulders Top (Bearish) : 

Left Shoulder : This peak, referred to as the first, indicates the highest point in the asset’s price during an uptrend.

Head: The central peak, also known as the head, is above the left shoulder and indicates a higher peak.

Right Shoulder: The second peak is on the right-hand side of the chart and is about the same height as the left shoulder. It usually indicates that the head is losing upward momentum.

Neckline:  This is a horizontal line drawn across the lows between left shoulder and head and between head and right shoulder.

When a head and shoulders top pattern completes, traders frequently consider it as a possible sign that the current uptrend is about to reverse and a downtrend is about to begin.

Head and Shoulders Bottom (Bullish):

Left Shoulder : This is the first trough and represents the bottom of the asset’s price range during a bearish trend.

Head: The lower part of the head, referred to as the central valley, is situated below the left shoulder, and constitutes the lower low.

Right Shoulder: Third valley, or right shoulder, is above the head but below the left shoulder.

Neckline: Like the bear pattern, the neckline is horizontal, but this time the neckline is drawn across the high points between the head and left shoulder and the high point between the head and right shoulder.

A head and shoulders bottom pattern’s completion is seen to be a possible indicator that a downtrend is about to end and an upswing is about to start.

What does it look like?? ????

Examples

Head and Shoulders Top (Bearish) :

Certainly, let’s summarise the key points in a more concise manner:

1. Chart Setup:

• Token is in an uptrend, rising from $80 to $110.
• The chart shows a pattern: Right peak at $110, head at $120, and left peak at $110.
• A neckline is drawn at $100.

2. Entry Point:

• To enter a trade, wait for confirmation of a reversal.
•  Enter the trade only if the price drops below the neckline at $100.

3. Exit Strategy: 

• Calculate the vertical difference between the head’s peak ($120) and the neckline ($100), which is $20 ($120 – $100).
• Determine the target price by subtracting this difference from the neckline, resulting in a target price of $80 ($100 – $80).

In summary, the exit strategy involves exiting the trade when the price reaches the calculated target price of $80, which is derived from the vertical difference between the head and the neckline.

Head and Shoulders Bottom (Bullish):

1. The chart
   1. Shows the price of a stock in a downtrend from 120 to 90
   2. The left shoulder is formed at 90
   3. The head is formed at 80
   4. The right shoulder is formed at 90
   5. The neckline is drawn at 100.
2. The entry strategy
   1. Wait for the confirmation of a reversal
   2. Enter the trade only when the price rises above the neckline of 100
3. The exit strategy
   1. Calculate the vertical price difference from the head to the neckline
   2. In this case, the difference is 20 (100 – 80)
   3. Add the difference amount to the neckline
   4. It will act as your target price
   5. Here, the target price would be 120 (100 + 20)

What does the head and shoulders pattern tell you ?

A technical analysis chart pattern known as the head and shoulders pattern usually indicates a possible trend reversal from bullish (upward) to bearish (downward). It has three peaks: the head, which is the highest peak, and the shoulders, which are the two slightly lower summits. This pattern indicates that an uptrend may be coming to an end and a decline may be beginning.

1. Reversal Signal:  Most people considered head and shoulders patterns to be reversal patterns. It indicates a possible reversal of the asset’s price trend from the current one. The pattern suggests a potential reversal of the uptrend when it appears following an upswing. When it appears following a decline, it suggests that the upward trend may be about to reverse.  
2. Bearish Pattern (Top Reversal): A head and shoulders pattern follows a long uptrend and is often interpreted as bearish. The left shoulder represents the first minor pullback, and the trend’s head is its highest point. The right shoulder represents the second minor pullback. The neckline links the bottoms together between the shoulders. The pattern is supported by a break below the neckline, indicating sellers may be taking control and the price could drop.
3. Bullish Pattern (Bottom Reversal):In a reverse head and shoulders pattern, the initial minor bounce is the left shoulder, the head is the bottom of the trend, and the second minor bounce, the right shoulder, supports the pattern. The upside breakout above the neckline suggests buyers may be gaining traction and the price could rise.
4. Confirmation: A bearish or bullish pattern is confirmed when a price breaks below or above a significant neckline on a large volume. The breakout is a confirmation of a reversal signal and could be a sign that a new trend is about to begin in the other direction.
5. Price Targets: The vertical distance from the top of the head to the bottom of the neckline is often used by analysts to determine potential price targets, and then to project that distance below a breakout point for a bullish pattern or above a bullish pattern.

How to use this pattern on Trading view ?

1. Selecting the Correct Timeframe and Asset: TradingView provides a range of technical indicators that can be used to identify patterns and trends. To find the specific indicator you need, click on the chart’s “Indicators” button (a beaker-shaped icon) at the top of the chart.

2. Identifying the Pattern: On the chart, you will see a series of vertical peaks and horizontal troughs. The left shoulder, head, and right shoulder are the main parts of the pattern. The head is going to be the vertical peak and the shoulders are going to be the two horizontal peaks on each side.

3. Drawing Trendlines: The “neckline” is the horizontal support line that connects the lows of your left shoulder and the lows of your right shoulder. This is a crucial level to keep an eye on for breakout or breakdown.

4. Confirmation: After forming the right shoulder, the price is considered to be completed when it breaks below its neckline. This is a confirmation of a potential reversal. Breaks below its neckline are a signal to short or to consider selling.

5. Price Target: Measure the vertical distance from head to neckline and project this distance down from the breakout point to get a target level for the potential price decline after the pattern completion.

6. Volume Confirmation: Volume can also be used to confirm the validity of the pattern. Generally speaking, you’ll want to see more volume during the break-out below the neckline. This means more selling pressure.
7. Stop Loss and Risk Management: Order your stop-loss above your right shoulder or your recent swing high, based on your risk tolerance, to protect your position in the event of a pattern failure and price reversal.

8. Monitor the Trade: Watch the price movement after the break-up. If you see the price test the neckline again from below and it doesn’t break above it, that’s another confirmation that the pattern is correct.

9. Consider Other Factors: Remember, no trading strategy is perfect. Combines the Head and Shoulders pattern analysis with additional technical indicators, fundamental research, and market sentiment.

To help you better grasp how to trade using this pattern, let’s look at a real-world example. :????

Example of Head and Shoulder pattern in Trading chart

Here, the Nifty trading chart displays the construction of a head and shoulder pattern.

It has been an upward trend for the stock. After that, the creation of the pattern becomes apparent.

Left shoulder: 17947.65

Head: 18604.45

Left shoulder: 18210.15

Neckline is drawn at : 17613.10

Example of Inverse Head and Shoulder pattern in Trading chart

Here, the Nifty trading chart displays the construction of an inverse head and shoulder pattern.

It has been a downward trend for the stock. After that, the creation of the pattern becomes apparent.

Left shoulder: 17297.30

Head: 16917.15

Left shoulder: 17579.50

Neckline is drawn at : 17840.45

Conclusion:

Basically, this trading pattern is a great tool for technical analysts and traders. It’s got three heads-like peaks between two shoulders, so it gives you an idea of when a trend could reverse. You can use it to position yourself for future price movements by spotting it and waiting for it to confirm through neckline breaks.

But don’t just rely on one indicator – use it with other analysis and risk management techniques to make smart trading decisions. Markets are influenced by a lot of different things, so it’s important to have this pattern in your toolbox so you can spot trend shifts and make better trading decisions.

FAQs

New to trading? Try crypto trading bots or copy trading on the best crypto exchanges

For on-demand analysis of any cryptocurrency, join our Telegram channel.

Top 10 Free Indicators for Trading Crypto

TOP 6 Play to Earn Crypto Games

Top 18 Crypto & NFT Marketing Agencies

TOP 5 Axie Infinity Staking Platforms: Earn Massive Rewards