Head and Shoulders Pattern
Definition of Head and Shoulders
The Head and Shoulders pattern is one of the most reliable and widely recognized chart patterns used in Forex trading. This pattern is used to predict trend reversals and is typically found in the following forms:
Head and Shoulders Top: Indicates a potential reversal from an uptrend to a downtrend.
Head and Shoulders Bottom (or Inverse Head and Shoulders): Indicates a potential reversal from a downtrend to an uptrend.
Components of the Head and Shoulders Pattern
Left Shoulder
The market makes a peak and then declines.
Head
A higher peak is formed after the left shoulder, followed by another decline.
Right Shoulder
The market makes a lower peak than the head, followed by a decline.
Neckline
A trend-line drawn through the lows (in a head and shoulders top) or highs (in an inverse head and shoulders) of the pattern.
Identifying a Head and Shoulders Pattern
Head and Shoulders Top
The pattern forms after an uptrend.
The left shoulder is created with a peak followed by a decline.
The head forms with a higher peak followed by a decline.
The right shoulder is formed with a peak lower than the head, followed by a decline.
The neckline is drawn connecting the lows of the left shoulder and the head.
Inverse Head and Shoulders
The pattern forms after a downtrend.
The left shoulder is created with a low followed by a rise.
The head forms with a lower low followed by a rise.
The right shoulder is formed with a low higher than the head, followed by a rise.
The neckline is drawn connecting the highs of the left shoulder and the head.
Trading the Head and Shoulders Pattern
Breakout Confirmation
For a Head and Shoulders Top, look for a breakout below the neckline to confirm the pattern.
For an Inverse Head and Shoulders, look for a breakout above the neckline.
Entry Point
Enter the trade after the price breaks the neckline and retests it.
Stop-Loss Placement
For a Head and Shoulders Top, place the stop-loss above the right shoulder.
For an Inverse Head and Shoulders, place the stop-loss below the right shoulder.
Profit Target
Measure the distance from the head to the neckline and project it downwards (for Head and Shoulders Top) or upwards (for Inverse Head and Shoulders) from the breakout point to set your profit target.
Example of Trading a Head and Shoulders Pattern
Head and Shoulders Top
Identify the left shoulder, head, and right shoulder formation in an uptrend.
Draw the neckline connecting the lows of the left shoulder and the head.
Wait for the price to break below the neckline.
Enter the trade after a retest of the neckline as resistance.
Place a stop-loss above the right shoulder.
Set the profit target by measuring the distance from the head to the neckline and projecting it downwards from the breakout point.
Inverse Head and Shoulders
Identify the left shoulder, head, and right shoulder formation in a downtrend.
Draw the neckline connecting the highs of the left shoulder and the head.
Wait for the price to break above the neckline.
Enter the trade after a retest of the neckline as support.
Place a stop-loss below the right shoulder.
Set the profit target by measuring the distance from the head to the neckline and projecting it upwards from the breakout point.
Conclusion
The Head and Shoulders pattern is a powerful tool in Forex trading, helping traders identify potential trend reversals. By understanding how to identify and trade this pattern, you can enhance your trading strategy and improve your chances of success. Always remember to use proper risk management techniques, including stop-loss orders and profit targets, to protect your capital and maximize your trading potential.
