How to trade using 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.