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Head and Shoulders Pattern

Basic Chart Patterns : Head and Shoulders Chart Pattern

Basic Chart Patterns : Head and Shoulders Chart Pattern

Head and Shoulders Chart Pattern

This is the second post of the basic chart patterns series in which you are going to learn the complete details about the Head and Shoulders Chart Pattern and the Inverse Head and Shoulders Chart Pattern such as the formation, identification and trading strategies of these chart patterns.

 

Head and Shoulders Chart pattern

The head and shoulders pattern is a trend reversal pattern. There are two types of head and shoulders pattern, the standard head and shoulders pattern found at the end of an uptrend and the inverse head and shoulders pattern found at the end of a downtrend.

types of head and shoulders pattern

 

Identifying Head and Shoulders Chart pattern

First of all lets look at the standard head and shoulders pattern and how you can trade it. Due to the head and shoulders being a reversal pattern, you want to look for it after a big up move.

The pattern is identified by its left shoulder, head, right shoulder and neck line.  Now that you know what the pattern looks like.

 

How to trade the Head and Shoulders Chart pattern

Let us look at two ways to trade the pattern.

Method #1

Head and Shoulders Method 1

Once you have identified a completed pattern with a formed right shoulder and price breaks below the neckline you can look to go short.

It is a good idea to wait for a candle close below the neckline before you look to enter a short position as it confirms that the bears are in control and avoids false brakes.

You can place the stop loss above the right shoulder in case the pattern fails and price continues moving up. To calculate the profit target measure the distance between the head and the neckline of the pattern and then extend this distance from the neckline in the direction of the breakout.

 

Method #2

Head and Shoulders Method 2

Another way to trade the head and shoulders pattern is to wait for price to break and close below the neckline as in the first example. This is noted as broken support.

However instead of entering after the close of the candle look for the price to retest the neckline before selling as this level is now seen as resistance by many traders. This will give you a better entry level and will allow for a smaller stop loss as you can place the stop loss above the new resistance area.

The profit target is found using the same method as before where you would measure the distance between the head and the neckline of the pattern and then extend this distance from the neckline in the direction of the break out so far.

 

Inverse Head and Shoulders Chart pattern

The inverse head and shoulders as the name implies is the opposite of the head and shoulders top pattern. It is the trend reversal pattern found at the end of a downtrend.

 

Identifying Inverse Head and Shoulders Chart pattern

Identify Inverse Head and Shoulders Pattern

As with the head and shoulders top pattern the inverse head and shoulders is identified by its left shoulder, Head, right shoulder and neckline. Due to the pattern being a reversal pattern you want to look for it after a big down move.

 

How to trade the Inverse Head and Shoulders Chart pattern

Method #1

Inverse Head and Shoulders Method 1

 

Once you have identified a completed pattern with a formed right shoulder and price breaks above the neck line you can look to go long. It is a good idea to wait for a candle close above the neckline before you look to enter a long position as it confirms that the bulls are in control and avoids false brakes.

You can place a stop loss below the right shoulder in case the pattern fails and price continues moving down.

To calculate the profit target measure the distance between the head and the neckline of the pattern and then extend this distance from the neckline in the direction of the break out.

 

Method #2

Inverse Head and Shoulders Method 2

Another way to trade the inverse head and shoulders pattern is to wait for price to break and close above the neckline as in the first example. This is noted as broken resistance. However instead of entering after the close of the candle look for price to retest the neckline before buying.

As this level is now seen as support by many traders this will give you a better entry level and will allow for a smaller Stop Loss as you can place the stop loss below the new support area.

The profit target is found using the same method as before where you would measure the distance between the head and neckline of the pattern and then extend this distance from the neckline in the direction of the break out.

 

Conclusion: Head and Shoulders Chart Pattern

This is all for the second post in the series of basic chart patterns. Hope this post was helpful for you. In case you have any queries/suggestions feel free to comment below.

The next post would be covering Symmetric Triangle chart patterns.

Also Read:

SGX Nifty Live Chart

How to do fundamental analysis of stocks

Income Tax on Share Trading Profit in India

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