Head and Shoulder Pattern Trading Strategy

Head and Shoulders Pattern Trading Strategy – Overview, Interpretation with Examples

by Vivek Bajaj on Basic Technical Analysis, Price Patterns, Technical Analysis

The Head and Shoulders pattern is quite popular amongst the market participants due to its reliability in the past and of course the success ratio.

Traders often study trends and patterns when analyzing the market, in hopes of detecting the next most probable price movement.

Spotting and correctly identifying patterns, and understanding their significance, is vital to successful trading.

To spot and correctly identify patterns you can join: Certification in Online Technical Analysis

Let’s understand the pattern in detail.

The Head and Shoulders pattern as the name suggest has the shape of a head along with two shoulders.

This is a reversal pattern and can act both as bullish and bearish reversal pattern depending upon the prior trend and type of this pattern.

The usual pattern is formed after an established uptrend which can be seen from the below image.

What is Head and Shoulders chart pattern in technical analysis?

This pattern gives a market reversal signal post breakdown from the neckline which is accompanied by heavy volume. The neckline is basically the horizontal line which joins both the troughs to each other.

The possibility of breakdown increases if the slope of the neckline is flat to downward sloping and the right shoulder is relatively smaller or equal to the left shoulder.

Another important aspect to remember is that post breakdown from the pattern, there may be a possibility of retest to the neckline.

The further breakdown is also accompanied with heavy volume which gives confirmation of the weakness.

The pattern can be formed in any timeframe from few minutes to weekly and monthly chart.

However, higher the timeframe, higher is the chance of success.

Before we continue, it’s important to keep in mind that the head and shoulders pattern is almost never perfect, meaning, there will likely be small price fluctuations in between the shoulders and the head, and the pattern formation is rarely perfectly shaped in its appearance.

What does inverse head and shoulders pattern mean?

Similarly we have Inverted Head and Shoulders pattern which is exactly a mirror image of the original pattern but is formed after a prior downtrend and is usually a bullish reversal pattern.

Head and Shoulder Pattern & Inverse Head and Shoulder Pattern

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Interpreting the Pattern: Determining target and Stop loss

This pattern is one of the popular patterns amongst trader community due to its pre-determined price target estimate after breakdown from the neckline.

The minimum target is vertical distance from the head to the neckline post breakdown.

Usually one can place stop loss at the high of the right shoulder and trail the same as the price corrects. With an inverse head and shoulders pattern, stops are usually placed at the low of the right shoulder.

Example of Head and Shoulders pattern:

Head and Shoulder pattern example Escorts Ltd

This is an example of this pattern formed in the daily chart of Escorts where post breakdown from the neckline, the stock witnessed sharp selloff and achieved the pattern target (shown by the blue line) in mere single candle.

Moreover, the breakdown was also supported with high volume which further confirmed the weakness.

Example of Inverse Head and Shoulders pattern:

Inverse Head and Shoulder Pattern example Bandhan Bank

The above image is an example of Inverted pattern pattern which was formed in the hourly chart of Bandhan Bank Ltd.

The stock witnessed sharp movement post breakout from the pattern on very high volume.

One important thing to note here is that there is no retest to the neckline here and moreover, the neckline is upward sloping.

Bottomline

To achieve your trading goal, it’s important to incorporate discipline and to adopt a proper risk management. This is the reason of popularity of Head & Shoulders pattern due its risk reward objective.

However, no pattern is 100% accurate but this pattern signals a change in trend and creates a profit opportunity with defined risk-reward.

You may take further confirmation of the possibility of breakout by tracking volume; slope of the neckline and with the help of technical parameters.


Disclaimer

Elearnmarkets.com wants to remind you that all our content is created solely for the purpose of education. No strategy, stock, commodity, fund or any other security discussed here is any way a recommendation for trading or investing. Elearnmarkets.com will not be any way responsible for trading losses incurred by any individual or entity for trading with real money. Please take advise of certified financial advisers before trading or investing.

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