Head and Shoulders Pattern – Technical Analysis
One of the oldest technical analysis patterns, the head and shoulders is a reversal pattern. Because it is a time-consuming pattern, traders spot it quickly and trade it accordingly.
Yet, this is both a blessing and a curse. When forming on more significant timeframes, if many retail traders position themselves on the same side of the market, the pattern often fails.
The standard interpretation of it is that it reverses both bullish and bearish trades. Hence, it forms at the end of a bullish or bearish trend.
But this is more like a rule to be broken. It isn’t mandatory for a strong trend to exist before the head and shoulders pattern to form. The market reaction should be similar.
The Pattern’s Elements
When forming at the market top, the head and shoulders is a bearish pattern. Conversely, when it appears at the end of a downtrend, the traders look to go long.
In both cases, it has the following elements:
- two shoulders – left and right
- one head
- a neckline
- a measured move
The two circles in the chart above show the potential left and right shoulders on the current USD/JPY daily timeframe. The movement lower followed by a quick retracement to the previous consolidation area is called the head.
For the head and shoulders pattern, the price action in the head is quite aggressive. That depends, apparently, on the timeframe.
The blue line is the neckline. As the name of the pattern comes from the human body, imagine a line connecting the two shoulders.
In technical analysis, it effectively means that the market consolidates before breaking it. In most cases, the right shoulder tends to be a continuation pattern, like an ascending triangle, a pennant or a bullish flag.
The black lines on the chart above show the measured move and its projection. Projected from the neckline, the measured move is just that: a measured move. It means that it represents only the minimum distance the price must travel for the head and shoulders to be confirmed.
Most of the times the price retests the neckline, but that’s not mandatory.
What traders do is they project the neckline from the market support on the left shoulder. Typically, that’s an area to enter on the long side (if the pattern reverses a bearish trend) or short side (if it forms after a bullish trend).
The head and shoulders pattern has the advantage of being visible. It takes time for the market to consolidate on the right shoulder, and the break is highly anticipated.
It has more chances to be confirmed if it appears on the lower timeframes. On big ones, it’ll attract attention and chances for it to survive become slimmer.
In any case, it does reverse trends on all timeframes, big or small. Hence, when the head and shoulders pattern appears, traders better pay attention.
This article was written by AMarkets