Head and Shoulders (H&S) is a classic technical analysis pattern that signals a reversal of the current trend. Many traders successfully use the H&S model on various charts (intraday, daily and weekly) to trade. The head and shoulders pattern exists in two versions:
- H&S:during an uptrend;
- Inverted H&S: during a downtrend.
This classic figure has a rather conventional construction. In other words, different traders may build the same H&S a little differently, depending on their understanding of the mechanisms of the foreign exchange market. In this case, each market participant will be right in their own way.
Head and shoulders is the most famous reversal pattern. It forms on tops and bottoms as a reversal formation, and develops during the current trend as a phenomenon of continuation or consolidation. Head and Shoulders has the reputation of being the most reliable signal among other similar patterns.
H&S consists of a final reversal of price (head), which separates two smaller reversals of price (left and right shoulder). The line connecting the bases of the two shoulders is called the line of neck. The model is considered complete when the line of neck is broken. For traders, this is a reliable signal of the current trend reversal. Head and Shoulders will be justified if this model is formed at the top of a sustainable trend.
First, the trader must make sure that the model is correct. For example, the price behaviour may show all signs of the H&S model, but the price does not cross the line of neck. It is believed that the model is not confirmed until the formation is completed with a final breakthrough. This is due to the fact that the line of neck is the support area, and the support has not been disrupted. When the line of neck is not intersected during the formation of model, the series of ascending or descending peaks is still continues.
Features of building a model H&S
- For formation of Head and Shoulders figure, a necessary condition is an uptrend, for Inverted Head and Shoulders figure is the presence of a downtrend.
- Head and Shoulders figure can only be considered as such after the price breaks through line of neck. Otherwise, the pattern may be false.
- The height shoulders should be about the same.
How to trade
At the beginning, the trader needs to make sure that there is a pronounced trend on the market and a reversal pattern is being formed. When the right shoulder is formed, trader needs to draw line of neck through the bottom two points of the H&S model and wait until the price intersections the line of neck.
Open a short trading position when the price chart intersections the line of neck.
Open a long trading position when the price chart intersections the line of neck.
Basic rules for trading
- Do not open a deal on the trend, as it can form a flat. Often this formation of the H&S model by the trend is a false breakdown.
- Opening deals only against the trend, when the line of neck is broken and a clear H&S model is formed after a pronounced uptrend or downtrend.
- Compliance with Money Management requirements.
- Compliance with Risk Management requirements.