This is the most popular chart pattern traded in the markets.
A head and shoulder pattern forms after an extended uptrend movement with three price peaks at different levels. The center peak is highest and other two peaks lower giving it the shape of a head and shoulders.
The left and right shoulder peaks are almost of same price level zone and same distance from the head but this is not usually the case. But they should at least be comparable. A support line is drawn on the lows of the left shoulder and the head.
This support line is also known as the neckline.
The formation of a head and shoulder in an uptrend signals the completion of the trend and the probable change in price direction to the downside. The pattern is completed after the break and close of the candle below the neckline. This confirms the Sell signal.
NOTE: Formation of the right shoulder DOES NOT confirm the head & shoulders entry signal. Always wait for the break of the Neckline to confirm entry to avoid false breaks.
The Stop loss is set just above the Right shoulder. The target is got by measuring the vertical distance from the head to the neckline and projecting that same distance downwards from neckline.
Let’s see some examples on how a head and shoulders patterns appears like and how to trade it.
Below is a USDJPY, 4-Hour chart. As we discussed previously, the confirmation for the sell entry is the break and close of bearish candle below the Neckline as shown on the chart below.
Stop loss is set just above the right shoulder and target measured and set as shown above i.e measuring vertical distance H from Head to Neckline and projecting that same distance H downwards as the profit Target as shown above.
This is a head and shoulders pattern on AUDUSD, 4-Hour chart below.
The Sell signal too was at break & close below the neckline (support line). The Stop loss just above the right shoulder . The target was got by simply measuring the height of the pattern (H) and projecting that same distance from the neckline downwards.
However, Stop-loss and target profits can also be adjusted depending on your preferred risk reward ratio. But for starters, better to trade it traditionally as you get used to new ways of adjusting the Stops and profit targets.
Let us now discuss the Inverse Head & shoulders
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