Head and Shoulders Pattern

Last Updated on September 19, 2021 by Alphaex Capital
Head and shoulders pattern for beginners

In this topic we will discuss the formidable head and shoulders pattern.

One of the best chart patterns in forex trading for beginners.

This chart formation is one of the most iconic and powerful in forex trading, so it is vital to be able to identify these patterns frequently and easily. 

It is also good to ensure you understand the use of support and resistance levels.

What is a head and shoulders pattern

These are formed after a series of 2 higher highs that have failed and another high that is roughly 50% of the previous higher high.

Head and shoulder patterns are easy to spot and you should get excited when you see them as they are a power chart pattern.

How to identify a head and shoulders pattern

You can quickly find head and shoulder patterns by switching to the line chart to confirm a potentially valid H&S pattern. This will give you a rough outline of the chart pattern without having to second guess all of the highs etc.

How To Trade Head And Shoulders Pattern - Identify - Line

See how the line graph easily identifies the formation’s shape. Obviously, when you trade this in real time you would only see the pattern emerging.

Head And Shoulders Pattern - Identify - Candlestick - Example

This is what it will look like on your chart using the candlestick patterns.

There are a couple of key factors to confirm a head and shoulders pattern’s validity these are:

Both shoulders should be between 25-65% of the range of the head and the neckline (this is the breakout line).

So, if the range between the head and the neckline is 100 pips, the shoulder’s highs can be no less than 25 pips and no more than 65 pips away from the neckline respectively.

The head part of the formation must be vertical with very little “hovering” around the top. Ideally, you want to see price get rejected and come straight back down. The longer it hovers, the longer it accumulates orders, the weaker the pattern can become.

Lastly, the pattern MUST be at the end of an uptrend.

How to trade the head and shoulders pattern

Now you know how to easily identify them, it’s time to learn how to trade them.

Let’s go through the entire process of validating and trading a head and shoulders pattern, from start to finish.

Step 1: Identify the Head & Shoulders formation

When you see a pattern that is at the top of an uptrend, that forms a high, larger high, then a high similar to the first – we can get a quick idea of the pattern emerging.

How To Trade Head And Shoulder Patterns - Identify - Candlestick - Example

Step 2: Draw the neckline

The neckline is the level of support under the pattern. To draw this, we must draw a line that goes along the most closes of the pattern. Using the same technique for drawing support levels, we switch to the line graph and draw the neck level.

How To Trade Head And Shoulder Patterns - Neckline

The white checks show that the price closed around this area and we have optimised the neckline. The white arrow showed confluence with a previous support level, giving us an indication that if the support/neckline is broken, then we should expect a completed pattern.

Step 3: Execute the trade based on our breakout rules:

How To Trade Head And Shoulder Patterns - Execute

As you can see in the example that there was a large candle that broke out from the head and shoulders pattern. This allowed us to add our entry levels as taught earlier on.

Remember the way that we teach = the highest possible accuracy on entering a trade.

Step 4: Find the Take Profit level

In this step we find out what the range between the peak of the head and the neckline is in pips. This gives us an expected potential breakout move.

How To Trade Head And Shoulder Patterns - Profit

In the example above, the range was 82 pips. Therefore, it is likely that the market will drop at least another 82 pips. (In fact it dropped an extra 24 pips from the neckline breakout).

In this case, we risked 24 pips to get a more accurate trade entry, without risking a fakeout. Plus the risk reward ratio was 1:2.41.

That is it, a very straight forward pattern that can be highly accurate with market reversals.

Things to note:

The neckline can be slanted like the examples, but it can also be horizontal. Horizontal necklines indicate a symmetrical balance between the buyers and sellers.

How to identify an inverse head and shoulders pattern

This is the same formation as head and shoulders but upside-down and is formed after a bearish trend.

The exact same rules apply.

How To Trade Inverse Head And Shoulder Patterns

How to trade the inverse head and shoulders pattern

Now you know how to easily identify this formation, we will show you how to trade them.

To put it bluntly, we use the exact same process as you would for normal head and shoulders, but the opposite.

Step 1: Identify the Inverse Head & Shoulders formation

When you see a pattern that is at the bottom of a downtrend, that forms a low, larger low, then a low similar to the first – we can start to see a pattern emerging.

How To Trade Inverse Head And Shoulder Patterns - Identify - Example

Step 2: Draw the neckline

The neckline is the level of resistance above the formation. We must draw a line that goes along the most closes of the pattern. Using the same technique for drawing resistance levels, we switch to the line graph and draw the neck level.

How To Trade Inverse Head And Shoulder Patterns - Neckline - Example

Here we have drawn a neckline that is at a 180-degree angle. This allows us to see the breakout clearer

Step 3: Execute the trade based on our breakout rules:

How To Trade Inverse Head And Shoulder Patterns - Execute - Example

As you can see in the example that there was a large candle that broke out from the inverse head and shoulders pattern.

Step 4: Find the Take Profit level

To do this we find out what the pip range is between the peak of the head and the neckline. This gives us an expected potential breakout move.

How To Trade Inverse Head And Shoulder Patterns - Execute - Example

In the example above, the range was 70 pips. Therefore, it is likely that the market will increase at least another 70 pips.

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