Head and Shoulders Pattern

 Magic of chart patterns

What Is the Head and Shoulders Pattern?

A head and shoulders pattern is used in technical analysis. It is a specific chart formation that predicts a bullish-to-bearish trend reversal. The pattern appears as a baseline with three peaks, where the outside two are close in height, and the middle is highest.

The head and shoulders pattern forms when a stock's price rises to a peak and then declines back to the base of the prior up-move. Then, the price rises above the previous peak to form the "head" and then declines back to the original base. Finally, the stock price peaks again at about the level of the first peak of the formation before falling back down.

The head and shoulders pattern is considered one of the most reliable trend reversal patterns. It is one of several top patterns that signal, with varying degrees of accuracy, that an upward trend is nearing its end.

KEY TAKEAWAYS :-

• A head and shoulders pattern is a technical indicator with a chart pattern of three peaks, where the outer two are close in height, and the middle is the highest.
• A head and shoulders pattern—considered one of the most reliable trend reversal patterns—is a chart formation that predicts a bullish-to-bearish trend reversal.
• An inverse head and shoulders pattern predicts a bearish-to-bullish trend.
• The neckline rests at the support or resistance lines, depending on the pattern direction.
  
  
  

  Understanding the Head and Shoulders Pattern

  A head and shoulders pattern has four components:

  1. After long bullish trends, the price rises to a peak and subsequently declines to form a trough.
  2. The price rises again to form a second high substantially above the initial peak and declines again.
  3. The price rises a third time, but only to the first peak level, before declining again.
  4. The neckline, drawn at the two troughs or peaks (inverse).

  The first and third peaks are the shoulders, and the second peak forms the head. The line connecting the first and second troughs is called the neckline.
  
  
  
  

  

  Inverse Head and Shoulders :-

  The opposite of a head and shoulders chart is the inverse head and shoulders, also called a head and shoulders bottom. It is inverted with the head and shoulders bottoms used to predict reversals in downtrends. This pattern is identified when the price action of a security meets the following characteristics:

  • The price falls to a trough, then rises
  • The price falls below the former trough, then rises again
  • The price falls again but not as far as the second trough
  • Once the final trough is made, the price heads upward toward the resistance (the neckline) found near the top of the previous troughs.

  
  
  

  Advantages and Disadvantages of the Head and Shoulders Pattern

  Advantages

  • Experienced traders identify it easily

  • Defined profit and risk

  • Big market movements can be profited from

  • Can be used in all markets

  Disadvantages

  • Novice traders may miss it

  • Large stop loss distances possible

  • Unfavorable risk-to-reward possible

  The Bottom Line

  The head and shoulders is a pattern used by traders to identify price reversals. A bearish head and shouders has three peaks, with the middle one reaching higher than the other two. It indicates a reversal of an upward trend.

  A bullish head and shoulders has three troughs, with the middle one reaching lower than the other two. It indicates a reversal of a downward trend.