Head and shoulders patterns consist of several candlesticks that form a peak, which makes up the head, and two lower peaks that make up the left and right shoulders. The right shoulder on these patterns typically is lower than the left, but it is often equal. Sometimes, there is a fake out, which makes the right shoulder higher than the left. They are a well-known pattern and probably one of the easiest to learn.
The head & shoulders pattern is a specific chart pattern informing of a bullish to a bearish trend reversal. Knowing this pattern can save the trader from becoming a bag holder. It is also one of the most reliable reversal patterns out there. It is pretty accurate at informing that an uptrend is ending. They are very fun to trade and come in various shapes and sizes!
Head and Shoulders Pattern Basics
The H & S pattern is easy to spot on any time frame. Therefore, it’s useful for day traders, swing traders, and long-term investors.
The pattern has four components: left shoulder, head, right shoulder, and neckline.
After a long bullish trend, the price rises to a peak and then falls to form a trough. This forms the “left shoulder.” Then, the price rises again, much higher than the first peak, followed by a decrease in price, which forms the “head.”
Another rise in price followed by a decline again forms the “right shoulder.” The line connecting the two shoulders is the key support level’s neckline. One that is usually broken on this bullish to bearish reversal pattern.
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Volume and Neckline Break
For this pattern to be confirmed, the uptrend needs to be broken. The reverse only happens once the neckline support has been broken.
It should be a convincing breakdown with increased volume to make that happen. Volume plays an important role in all aspects of this pattern. Ideally, the volume would be higher during the left shoulder formation; however, it only sometimes happens this way.
The decrease in volume followed by the formation of the head acts together as a warning sign. The next warning sign occurs when volume increases during the decline from the peak of the head.
It then decreases as the right shoulder forms. Final confirmation comes when the volume increases during the fall of the right shoulder. That is when the neckline breaks.
Head and Shoulders Pattern Example
This is a head and shoulders example on a 5-minute chart of $MTCH. Note that when you look at the highlighted areas, there are three of them. The first one was the day’s intraday high which formed the left shoulder. The second peak level formed the new high of the day, which was the head area. Then, the right shoulder area formed the third peak.
Once the third peak formed the right shoulder, you’ll see that it didn’t go back up to the head area, which showed weakness and, ultimately, neckline failure. Traders enter a short position as the price fails the neckline and place their stop loss above the right shoulder area. As the price failed the neckline area, it formed a falling wedge pattern, which created an extended new right shoulder.
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Trading Head and Shoulders Patterns
- Watch for the first high to form, which will end up being the left shoulder.
- Once the first high is formed, watch for the price to break above that level, forming the head.
- Next, look for price action to fail, then get a bounce back up to the left shoulder area.
- Watch for right shoulder formation, then failure at left shoulder area.
- Some traders take a short position at right shoulder rejection using a close above as a stop.
- The “safest” most conservative trade is to take a short below neckline failure, using a close above right shoulder as a stop.
Daily chart $ASNA shows two H&S patterns. The first one was completed and opened with a gap down. It started to head back up, creating another head and shoulders pattern. Before it again broke back down.
Before the second pattern took place there was an inverse h&S pattern. The inverse head and shoulders are a bullish pattern. It shows that important support levels are holding. This is also a bigger cup and handle pattern overall. Once the second head and shoulders happened, it became a falling wedge pattern.
The neckline of the H&S patterns is a key support level. When the price falls below the neckline, that support level becomes resistant.
Usually, the price will reverse to the new resistance level. This offers a second chance to sell. This is why traders need to wait for the pattern to complete.
Never assume a partially developed pattern will be completed in the future. Never make a trade until head and shoulders patterns break the neckline. Those support and resistance levels are key. Always wait for confirmation.
Frequently Asked Questions
A head and shoulders pattern is one of the most reliable patterns. The first high is formed, which makes up the left shoulder. Then, price action breaks the left shoulder high and creates a new high, thus forming the head. Price falls, gets a bounce, and retests the left shoulder resistance area again but fails.
A head and shoulders is a bearish pattern. It starts as bullish but turns into a bearish reversal when the price fails the neckline area. The warning happens when the right shoulder is lower than the left shoulder.
The rule of the head and shoulders patterns is to take a bearish position once the price fails the neckline area and put a stop loss above the right shoulder.
Head and shoulders are always bearish patterns, but sometimes they do fail. The right shoulder area shows weakness because the bulls can't push the price back over the previous resistance level at the head and left shoulder area.
The head and shoulders pattern has an 85% accuracy rate and is one of the most reliable bearish patterns. They do fail, so it's important to have proper risk management strategies implemented.