In technical analysis, the head and shoulders chart pattern is a well-known and easy-to-spot pattern that shows a baseline and three peaks, with the middle peak being the highest. ...
In technical analysis, the head and shoulders chart pattern is a well-known and easy-to-spot pattern that shows a baseline and three peaks, with the middle peak being the highest.
On the head and shoulders chart, there is a change from a bullish to a bearish trend, which also shows that an upward trend is about to end. The pattern can be used by all traders and investors because it shows up on all time frames.
Because the chart pattern shows important levels that are easy to see, it is easy to set entry levels, stop levels, and price goals for the formation.
Why the "Head and Shoulders" Pattern Works
There is no perfect pattern, and they don't always work. But the chart pattern is true in theory for a number of reasons (we'll use the market top as an example, but it's true for both):
As prices fall from their market high, people are buying less aggressively (head). The market has also started to get sellers.
As the neckline gets closer, many investors who bought during the penultimate wave higher or during the right shoulder rally are now facing big losses because they were wrong.
They will now sell their positions, which will push the price in the direction of the profit objective.
The head is higher than the right shoulder, so it makes sense to put a stop loss above the right shoulder. The trend has changed to going down, so the right shoulder is unlikely to be broken until the trend goes up again.
The profit goal is based on the idea that people who made mistakes or bought the security at a bad time will be forced to sell. This will cause a reversal that is about the same size as the recently formed topping pattern.
Many traders will start to feel pain at the neckline and be forced to close out their positions. This will move the price in the direction of the price objective.
You can also pay attention to volume. When there is an inverse head and shoulders pattern, we would like the volume to go up as the breakout happens (market bottoms).
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Because there are more people buying, the price will move closer to the goal. Volume is going down, which shows that people aren't excited about the uptrend and calls for some skepticism.
Head-and-shoulders patterns appear in all time frames. The full pattern gives entry, stops, and profit objectives, making trading straightforward.
The pattern is left shoulder, head, right shoulder. The most typical entry point is a neckline breakout with a stop above or below the right shoulder.
Profit goal is high-low pattern difference added (market bottom) or removed (market top) from breakout price.
The strategy isn't flawless, but it allows traders to trade rational price fluctuations.