- Head and shoulders patterns are technical indicators used by all types of Forex trader.
- Traders find the pattern reliable and often easy to draw on every time chart.
- Head and shoulders patterns have four elements: head, neckline, and left and right shoulder.
- Inverted head and shoulders patterns indicate a bearish-to-bullish trend reversal.
A head and shoulders chart pattern is a widely used indicator for predicting bullish-to-bearish trend reversals in Forex trading. One ultimate strategy that wins every time doesn’t exist in Forex markets, but the head and shoulders pattern comes close to being a rule of technical trading. The pattern forms on all timeframes, which is favourable to all Forex traders and different Forex trading strategies. The $19 trillion daily-volume Forex market is hectic at best and highly volatile at worst. Millions in fiat currency exchange hands every millisecond, making it nearly impossible to hack the market with one ultimate strategy. Many rely on head and shoulders technical indicator to predict a future price trend and execute a market position. Traders may predict a complete bullish-to-bearish reversal and pocket high returns on their investment.
What is the Head and Shoulders pattern?
The head and shoulders pattern is a V-shaped formation, most-often used in price action trading. The pattern signals a reversal after a period of a strong uptrend. Conversely, the pattern can invertedly formed during a downtrend, signalling a possible trend change to an uptrend. Inverse head and shoulders patterns have all the elements of an uptrend pattern, only mirrored in a downtrend.
Four essential elements make the Head and Shoulders pattern:
- Left minor peak (left shoulder)
- Right minor peak (right shoulders)
- One high central peak (head)
- One straight line (neckline)
The pattern literally resembles a human head and shoulders. But the formation is not always clear-cut, and some market noise can happen between peaks. The neckline ties the whole pattern together. Traders draw a line (often red or black in colour) to represent the neckline visually. Without the neckline, traders would have difficulty spotting the pattern and could confuse it with other formations. The Head and Shoulder Pattern has three different necklines.
- Rising slope line. The pattern is risky when the neckline is inverted with an uptrend. Rising slope lines can be highly subjective, and other traders may disagree with your analysis.
- Horizontal neckline. Every trader can spot a horizontal neckline in their dashboards, making this pattern a safer bet than the rising slope. The horizontal line is straightforward and doesn’t leave much room for confusion.
- Downturn slope line. Many traders consider the downtrend formation as the most powerful indicator of a trend reversal. The neckline is inclined, and the head and shoulder formation gather momentum to break the psychological resistance levels.
How to trade head and shoulders pattern?
Once you know how to spot both an inverse head and shoulders pattern and a regular uptrend pattern, you can start placing trades. Always place a stop/loss order with every trade. Forex traders hedge against unpredictable volatility, personal emotions, and risky decisions that can jeopardize a trading portfolio. Using the neckline as a stop/loss baseline sounds like common sense, but it’s risky. The price may come back to retest the new resistance level and trigger your stop. Place the stop/loss near either of the shoulder peaks to reduce the risks while having enough leeway to score a victory.
Take profit at a difference between the head’s peak and the lower shoulder’s peak. If the EUR/USU chart forms a head is at $1.20214, and the lower shoulder peaks at $1.194813, add the difference to the entry price to identify a favourable exit point. Traders also measure the distance between the head and neckline to determine the profit targets. Simply mirror the head over the neckline, and use that price as a profit target. Depending on a candlestick timeframe, a head and shoulders trade can take anywhere between a day to a few months to execute.
When to enter a position following the head and shoulder formation?
Trade only when the price breaks the neckline. Otherwise, you may hit a consolidation momentum. If you spot an exact formation on a 30-min chart and want to short a currency pair, wait for the price to break the neckline with a fully formed bar. Otherwise, the market can quickly turn against you. Common pitfalls of trading The Head and Shoulders pattern
- The strategy doesn’t work every time. The Forex market is collective psychology that depends on several fundamental factors that almost always trump any technical indicator.
- Unpredictable events may disrupt technical analysis. News of political turmoil can cause a spike in price that can trigger a stop/loss order.
- Patterns can be highly subjective. What one trader sees on a screen may not be what everyone sees. The Head and Shoulder pattern works only if the market collectively agrees on its formation.
- Traders could miss profit targets. Forex traders can’t always rely on a Forex indicator. You may not hit your profit targets every time, so knowing when to close a trade-in price action trading can be an art form.
Takeaway: Head and Shoulders Forex chart pattern The patterns occur in every timeframe, and both beginners and professional traders can draw an effective neckline. The formation is generally favoured as one of the most reliable trading indicators. Every head and shoulders pattern has four essential elements: two shoulders, one head, and a neckline. The head and shoulder pattern signals a bullish-to-bearish trend reversal. Conversely, an inverted head and shoulders pattern forms on a downtrend, signalling the high likelihood of a trend reversal occurring. Traders may not always hit their profit targets, so always ensure that you have the stop/loss order in place and know your potential risks.