#1 mitch77

mitch77

Advanced Member

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• Location UK

Posted 29 May 2013 — 05:35 AM

The head and shoulders chart pattern is a pattern that falls into the class of bearish reversal chart patterns. Head and Shoulder chart patterns occurs at the top of a trend and is usually used as a determinant of a bearish reversal of the existing bullish price action.

A head and shoulders Forex chart pattern is made up of:

1. Candlesticks that form a crest (the shoulder 1)

2. Second crest which is usually higher than the first one (the head)

3. Third crest which is not as high as the second, and may or may not be as high as the first crest (shoulder 2)

Head and Shoulder chart patterns can be a bottoming formation after a downtrend or a topping formation after an uptrend. The bottoming pattern is a low price then followed by a retracement then a lower low, the head, and a retracement then a higher low which is the shoulder. On the flip side, a topping chart pattern is a high followed by retracement then a higher price high and finally a lower low. Head and shoulder chart pattern is complete when the trend line which connects the 2 highs, bottoming pattern, or 2 lows, the topping pattern, is broken.

Application of Head and Shoulders Chart Patterns

To be able to identify Head and Shoulders chart patterns, there are 3 crucial things:

1. Have an eye to see how the candlesticks line up

2. Have the ability to use the drawing tool of your Forex trading system to make the appropriate traces across the highs of the candlesticks

3. Draw a correct neckline, which is the landmark for the trade entry

You should ensure that the head and shoulder have to fully form with the 2nd shoulder being almost complete before placing a Sell stop. The Sell stop should be placed about 5 pips below the neckline. When you are using Head and Shoulders chart patterns to trade in the Forex market you should know that the extent of the bearish reversal of the price action is equidistant to the distance between the neckline and the peak of the head. This is the profit point you should be eying. It is worth mentioning that the entry signal is usually reinforced when the price action is in an overbought region or is at a resistance level.

It is very important that traders wait for the head and shoulder chart pattern to complete before they make a move. One should not assume that a pattern will develop, or become complete in the future. You should watch partial patterns keenly but you should not make any trades until the head and shoulder pattern breaks the neckline. The neckline is the landmark for the trade entry.

On the other hand, for the inverse head and shoulder, you should wait for price movement above the neckline after the right shoulder to be formed. A trade can be initiated as the chart pattern completes. You should always plan your trade beforehand, jotting down the profit targets, variables that may change your revenue target, entry as well as stop points.

Just like there are two sides of a coin, trading using head and shoulder chart patterns has its limitations. First and foremost the chart pattern is not perfect and as such can fail at times. This chart pattern is not always tradable. For instance, in the event that there is an extensive drop of one shoulder due to unpredictable even then there is a high likelihood that the price target will not be hit. Bearing in mind that you have to wait for the pattern to develop fully, it could mean waiting for longer periods which can affect your trading.

In conclusion, though head and shoulder patterns can be subjective at times and take long to develop, the complete chart pattern provide entries, profit targets and stops making it easier to implement a trading strategy.