3.10 Head and Shoulders Chart Pattern
Be on your guard when the head and shoulders pattern appears on the charts – it usually signals a reversal of the current trend.
We talked about triple tops earlier which is a rare occurrence. Head and shoulders pattern is a slight variation of the triple top pattern and occurs more frequently.
If a man just shrugged, and you snapped a picture of his shoulders and head, you caught the pattern we are about to explain here!
In an uptrend, it is formed by prices making a peak and retreating (the left shoulder), then pushing up to make another, higher shoulder (the head) and retreating again and then finally making another peak (the right shoulder). The fall from the right shoulder is decisive, and breaks through an imaginary line we can call the ‘neckline’, which is drawn through the troughs the price made on either side of the head. A look at the chart below will make this clear.
How to Trade with Heads and Shoulders Pattern?
One can usually count on the price sliding to a ‘target’ level that is below the ‘neckline’ by approximately the same amount as the height of the ‘head’ above the line.
We trade this pattern by entering a ‘sell’ order just below the neckline and covering it around the target point. Do I hear you thinking “that’s easy money”? Maybe, all the same, never forget to put in that stop-loss order!
Inverted Head and Shoulders Pattern
This is just the head and shoulders pattern – only it is turned upside down. You still have that pic? – Well go ahead and turn it so the man’s head is pointing downwards! There, now you have the inverted head and shoulders pattern.
This hopeful pattern appears at the end of a downtrend in the stock. You see prices hit a bottom and then move up (forming a valley, the left ‘shoulder’), but wait, there’s more downside; the prices again form a lower bottom (this is the inverted ‘head’) and then another, higher valley (the right ‘shoulder’). Here too, if you drew a line across the pattern joining the two valley highs, we would call this a ‘neckline’.
Look at the chart below and let’s see how we could have raked in the moolah!
Trade this pattern by placing a buy order just above the ‘neckline’ and look for prices to reach the target zone, which is, you guessed it, a point as high above the neckline as the distance the inverted head is below the line. That wasn’t so difficult, was it?
- Trading with Head and Shoulders Chart Pattern