Chart Pattern #1: Head and Shoulders
Do you remember playing tug-of-war?
What qualities does it take to win?
It has to be the team with the best use of strength and coordination, right?
While those things can help, it’s the team that believes they can reverse things in their favor that wins.
That’s what the head and shoulders pattern is showing us.
It’s a never-ending game of tug-of-war between the bulls and the bears in the marketplace.
Understand the Head and Shoulders Pattern
The head and shoulders pattern is simply a trend reversal formation.
It starts out from the left to form a shoulder that peaks, then continues to form a head at its highest peak, and finally comes back down to form another shoulder with a lower peak on the right.
A neckline is then formed when the two troughs of the left and right shoulder connect as seen below.
What It Means
This signifies that tug-of-war between the bulls and bears as they alternate pulling the price up and down.
The left shoulder represents a price peak.
Price then declines and rises up again to form the highest peak at the head… and declines again followed by another rise in price that’s lower than the head.
This is a constant pattern that appears in all time frames.
It can be used by all traders of varying skill levels.
How To Trade with Head and Shoulders
You want to wait for the pattern to complete and enter a position at the lowest point of the neckline. It’s even better if the price moves lower than the neckline.
That means you want to have your entry and exit planned when you reach the profit target at the highest peak on the next cycle.
How Will it Benefit You?
Learning how to read the head and shoulders pattern will help you anticipate better entry positions and exits for desirable profits.
That’s because when the head is fully formed, too many buyers overvalue the asset which eventually creates a bubble that leads to a decline in price.
With less buying going on…
The assets essentially get discounted. This is the opportunity to enter before the assets rally again.
The Risks
As you know, nothing is perfect and there are risks involved:
- You have to wait for the pattern to fully develop on the chart. This requires incredible patience.
- You won’t always reach your profit target due to market variables.
- Unforeseen variables such as real-time events can affect the peaks for better or worse.
- The patterns can be subjective to other traders which means erratic reversals based on the volume of entry points.
It’s Still All Good
While head and shoulders patterns are universal and constant, they have their risks.
But they still allow for desirable entries, stops and profits
So make sure you have a trading strategy set in place and be ready to strike when the time comes.