By Richard Hill on October 05th, 2011

Anyone could show you an amazing chart pattern from last week’s markets

And I bet a fair few traders could then go on to brag about what a great trade they made.

I mean, when I opened my 1-hour EUR/USD chart the other morning

Well, this chart was pretty much screaming at me.

Don’t get me wrong though, I’m not bragging. I didn’t actually see this at the time and sadly I didn’t place a trade.

It’s a shame, but still there’s a lot we can learn from it. It really is an amazing example of chart theory in action:

Can you see what it is?

Yes, it’s a classic head and shoulders pattern .

In fact, let’s zoom in on the head and the shoulders

As you can see, you’ve got three highs (high price points) that were rejected, and the middle high is higher than the two on either side of it

Hence you have a ‘head’ in the middle with two ‘shoulders’ either side.

What this means is that the market was rising on three occasions but then stopped and turned at similar price points.

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The interesting thing is, after seeing a Head and Shoulders pattern; it’s often the case that you’ll see a big price fall after the right hand shoulder.

So, the short term high in the EUR/USD seemed to be have been confirmed just below the 1.3700 level.

I know it’s often much easier spotting these after the event.

But let’s say you were following the EUR/USD 1 hour chart last Thursday evening.

When you saw the third high (the right hand shoulder) on the right hand side of your chart.

You could have been thinking this could be a Head and Shoulders forming

You wouldn’t know for sure but you might have started to watch whether the price would turn down from there.

And sure enough, at 11am on Thursday, the third high of 1.3680 turned out to be a bearish red candlestick.

It would have been another clue.

And if you were an aggressive trader you could have entered a sell trade at the end of that candlestick.

To trade this you would probably have to place your stop loss above the third high.

That would have been around 100 pips above your entry price.

But you may have wanted to wait for another confirmation of the market turn before placing your sell trade.

So, you may have waited until there was another bearish candlestick and that duly came at 6pm on Thursday when the 5pm candlestick closed.

That’s the candlestick marked by the cross hair on the next chart below.

If you’d have gotten in then, that would have given you a sell price of 1.3584.

And you could have placed your stop loss order above the middle ‘head’ high to give the trade room to move that would have been around 130 pips above the entry price.

But to make this trade worthwhile you would have needed a profit target at least as big as your stop loss.

You see you have to make sure you have an adequate potential reward for taking 130 pips of risk.

So, you would have been looking for at least 130 pips profit on the trade.

And if you had done so you would have been rewarded the EUR/USD fell all day Friday!

In fact, it dropped almost 200 pips.

So, there was plenty of profit in this trade.

And it continued falling on Monday almost another 200 pips!

It’s a great example of a classic chart pattern operating exactly as you’d expect it to.

And it just shows that it really can be very worthwhile studying the patterns like we often do in Round Up.

Next time you spot a classic head and shoulders pattern forming, it could well help you get in on a huge trade.