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 many of times it is equal. Sometimes there is a fake out which makes right shoulder higher than the left. They are a very 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 bearish trend reversal. Knowing this pattern can save the trader from becoming a bag holder. It also happens to be one of the most reliable reversal patterns out there. It is pretty accurate at informing that an uptrend is coming to an end. They are very fun to trade and come in a variety of shapes and sizes!
The H&S pattern is pretty easy to spot on any time frame. Therefore, its useful for day traders, swing traders, and/or even long term investors.
The pattern has 4 components: left shoulder, head, right shoulder, and neckline.
After a long bullish trend, price rises to a peak then falls to form a trough. This forms the “left shoulder.” Then 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 that connects the two shoulders is the neckline; which is a key support level. One that is usually broken on this bullish to bearish reversal pattern.
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.
Volume and Neckline Break
For this patterns to be confirmed the uptrend needs to be broken. The reverse does not happen until the neckline support has been broken.
It should be a convincing breakdown with an increase in volume to make that happen. Volume plays an important role in all aspects of this pattern. Ideally, volume would be higher during the formation of the left shoulder; however, it does not always happen this way.
The decrease in volume followed by formation of the head act 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.
How to Trade Head and Shoulders Patterns
- Watch for first high to form which will end up being left shoulder.
- Once first high is formed, watch for price to break above that level forming the head.
- Next, look for price action to fail then get a bounce back up to left shoulder area.
- Watch for right shoulder formation then failure at left shoulder area.
- Some traders that 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 stop.
Support Turned Resistance
The neckline of the H&S patterns is a key support level. When price falls below the neckline, that support level now becomes resistance.
Usually price will reverse to the new resistance level. This offers a second chance to sell. This is why it’s very important for traders to wait for the pattern to complete.
Never assume a partially developed pattern will complete 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 left shoulder high and creates a new high, thus forming the head. Price falls, gets a bounce and retests left shoulder resistance area again but then fails.