How to trade using Head and Shoulders Pattern?

Today we are going to learn about Head and Shoulders Pattern

So for we have seen Triangle pattern, Flag pattern, Cup & Handle pattern and I hope you have liked it and understood better. This week let us learn about a bearish reversal pattern, which is Head and Shoulders pattern.

A Head and Shoulders is a bearish reversal chart pattern and as the name suggests it looks like head and shoulders.

Different parts of Head and Shoulders pattern

There are four major parts which forms this pattern.

1. The left shoulder – Inverted U – The market does a pullback and forms an inverted U shape. At this point, there’s no way to tell if the market will reverse because a pullback occurs regularly in a trending market.
2. The head – Inverted V/U – The market trades above the previous high. However, the sellers took control and push the price lower towards the previous swing low (forming the Neckline and a big inverted V/U shape).
3. The right shoulder – Inverted U – The buyers make a final attempt to push the price higher, but it failed to even break above the previous high (the head). Then, the sellers take control and push the price towards the Neckline, forming another inverted U shape.
4. The neckline/trendline – This is the last line of defence for the buyers. If the price breaks below it, the market could reverse, head lower and begin the start of a downtrend.

Things to Remember,

1. H&S formation should be as straight as possible and it should not be sloping up or downside too much. A perfect H&S should have equal highs on both side of the head but this is not possible all the time. So slightly sloped H&S also ok, but not too much tilted!!
2. The lesser the height of the second shoulder, the better it as this indicates the consolidation, so a sharp move or too much height on the second shoulder isn’t a good sign and such trades should be avoided.

Connecting Head & Shoulders through Trend line

Once you identify the head and shoulder formation, just draw a straight line in bottom which connects head and shoulder. We will get a technical breakout when the price gives breakout below the line drawn.

Volume Factor on Shoulder part

As I always say, the volume is most important thing you need to check for technical breakout in any pattern. So a perfect head and shoulder pattern will give double confirmation when the price gives breakout with big volume.

Entry, Target and SL

You can enter into the trade once the price gives the breakout below the trend line or neckline drawn.

But if you are new trader, you can enter the trade during pullback, in this example, an inverted flag is being formed during the pullback and you can use it to entry the trade.

If you are an experienced trader, you can even enter the trade once 50% of the 2^nd shoulder is formed, provided the chart print a candlestick reversal pattern. Refer our Price Action Trading series for more details about candlestick reversal pattern.

The target for this pattern is arrived by measuring the height of the head from neckline. So if the height of the head is say 100 points then the technical target is 100 points from the breakout line or neckline. But if you enter early at 50% of right shoulder or enter late during pullback, you should adjust your target accordingly.

When it comes to SL, Once the price is given a downside breakout below neckline, the neckline point becomes your immediate resistance and you can keep high price of the shoulder (or) head as your SL based on the formation of head/shoulder. But if you enter early at 50% of right shoulder or enter late during pullback, you should adjust your SL accordingly.