Head and Shoulders Pattern is a formation of a predictive chart in the form of a bullish reversal to bearish or vice versa. The head and shoulders pattern itself can be imperfect on every chart. For a more complete explanation, you can understand it through the article below. Before that, make sure to register at GIC to be able to continue to update and trade forex with GIC!

 

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Understanding the Head and Shoulders Pattern

In terms of technical analysis, the head and shoulders pattern is a predictive chart formation that usually indicates a trend reversal where the market shifts from bullish to bearish, or vice versa. The pattern has long been praised as a reliable pattern that predicts trend reversals. Before we go any further, it is important to note that the head and shoulders pattern is almost never perfect, meaning that there will likely be small price fluctuations between the shoulders and the head, and the pattern formation is rarely perfect in its appearance.
 
There are three main components to the head and shoulders pattern. Before we explain each part, take a look at the image below.


Head and Shoulders Pattern: Ciri-Ciri, Cara Membaca, dan Contoh Pola

This image is a clear representation of the three parts of this pattern – the two shoulder areas and the head area that price passes through in creating the pattern that signals a market reversal. The first “shoulder” forms after a significant bullish period in the market when price rises and then falls to a trough. The “head” then forms when price rises again, creating a high peak above the level of the first shoulder formation.
 
From this point, price falls and creates a second shoulder, which usually looks similar to the first shoulder. Importantly, the initial decline does not carry significantly below the level of the first shoulder before there is usually a slight upward retracement or flat price movement. The pattern completes, signaling a market reversal, when price falls again, breaking below the neckline. The neckline, as depicted above, is the horizontal line that connects the first two troughs to each other.

Characteristics of the Head and Shoulders Pattern

Recognizing the Head and Shoulders pattern on forex and stock charts requires exactly the same actions; making it a versatile tool to include in any trading strategy. The following list provides a simple breakdown of the key action points when identifying this pattern:
  1. Identify the overall market trend using price action and technical indicators (before an uptrend)
  2. Separate head and shoulder chart construction
  3. The distance between the 'Head' and 'Shoulders' should be as close to the same distance as possible.
  4. Draw the neckline at the low point between the two 'shoulders' – preferably horizontal but not mandatory.
These steps apply to identifying both standard and inverse head and shoulders patterns.

Example of the Head and Shoulders Pattern

In this candlestick chart (which shows daily highs and lows, and closing and opening prices) depicted below, Apple’s stock price action from late 2021 to early 2022 highlights a head and shoulders pattern.
 
On the first shoulder, from early to mid-December, the stock rallied to a peak, and then declined. It bottomed before rallying again toward the end of December and making a new high to form a peak, or head, in early January.
 
The stock then declined before making a new low. The next rally peaked and formed the second shoulder. When the stock’s decline broke through the same price levels established at the end of the first shoulder and the beginning of the second shoulder, sentiment turned bearish. The level at the trough is known as the neckline, and the downward slope of the stock is known as a breakdown.
 
In Apple’s case, the breakdown reached price levels not seen since November. The stock held steady before rallying following the release of strong quarterly earnings and record revenue.
Ideally, the first and second shoulder peaks will be at the same price level, but this is not always the case.



Apple’s head and shoulders pattern began forming in early December, and the price dropped around January to levels not seen in about two months. Below is an example of a head and shoulders pattern forming on a Bitcoin candlestick chart. After forming the left shoulder, head, and right shoulder, the cryptocurrency fell through the neckline, signaling that it would continue to decline. In this case, the right shoulder is quite small. The fact that the price was unable to bounce back significantly suggests that there was a lot of selling pressure before the decline. This is what is called a head and shoulders top chart pattern.

How to Read Head and Shoulders Pattern

Setelah seorang trader mengetahui bagaimana mengidentifikasi standar dan pola inverted head and shoulder, relatif mudah untuk menerapkannya pada analisis teknis baik di pasar valas dan ekuitas. Trading saham dengan pola Head and Shoulders


The chart above shows a Head and Shoulders pattern on the Germany 30 stock index (DAX 30). The formation of the pattern is clear with the neckline highlighted by the dashed blue horizontal line. Traders will look to enter a short trade upon confirmation of a close below the neckline as seen by the ‘ENTRY’ label on the chart or a pip movement below the neckline.

Some traders use the ‘two-day’ close rule which requires a second confirming candle to close below the neckline before opening a short trade. Trading on a pip break below the neckline allows traders to profit from a full down move, but this tactic is riskier as the break below the neckline has not been confirmed by a candle close.

There are general rules for determining stop and limit levels. Taking the high of the ‘right shoulder’ will determine the stop level while the vertical distance between the neckline and the high of the ‘head’ will approximate the limit distance – 1832.8 pips in this case. The risk-reward ratio on this trade is approximately 1:1.2 which is well within recommended risk management parameters.

Also read : 

Characteristics and How to Trade the Inverted Head and Shoulder Pattern

Type of Head and Shoulder Pattern

Here are the types and examples of each type of head and shoulders pattern. These types are:

Head and Shoulder Bullish

The following example will explain how to trade a bullish head and shoulders. Essentially, we follow the same set of rules. Once we have drawn all the key elements, we wait for the NZD to rise to push the price higher.



Previously we discussed the two options available to set up your entry. This example falls into the second option and perfectly shows why this is the riskier option. As you can see, the bulls never came back to retest the broken neckline once the breakout occurred. Therefore, if you had chosen to wait for the retest, you would have missed the trade.

By choosing the first option, you would enter the trade after a daily close above the neckline has been secured. The stop loss is again placed below the neckline, while the blue line measures the distance for the take profit order. A few weeks later, the inverted head and shoulders pattern is completed. In this case, we risked 70 pips to gain about 200 pips, which makes the risk-reward ratio almost 1:3, meaning this is an excellent setup from a risk tolerance perspective.

Head and Shoulder Bearish

Contoh yang sama untuk memberi Anda panduan langkah demi langkah tentang cara memperdagangkan pola head and shoulder bearish.



The first option offers you the opportunity to enter a short trade as soon as the neckline is broken and the daily candle closes below the broken neckline. This option means that you cannot miss the trade. However, this one is also riskier as this move lower could easily prove to be a failed breakout. In this case, your stop-loss would be triggered almost instantly. The second option is preferred by the majority of the trading community. It is based on the idea that you should enter once the price action closes below the neckline and the breakout is confirmed.
 
Therefore, buyers will then push the price action to retest the neckline, which is called a “throwback”, before continuing lower. So, you should place your entry when the throwback occurs. Of course, the price action can still return above the neckline, but the chances of this happening are less than with the first option. The limitation of the second option is that the price action can easily continue lower without making a pullback i.e. a retest of the neckline is not guaranteed. USD/CAD closes below the neckline every day, then buyers push the price higher the next day, before finally sliding lower.
 
From a risk-reward perspective, this is a perfect scenario because you are given the opportunity to enter the trade on the retest. Wherever you decide to place your entry, your stop-loss should be placed above the neckline. It is always recommended that you leave a cushion between your stop-loss and the neckline. As you can see in our example, buyers were able to trade briefly above the neckline before being rejected.

Take profit is calculated by measuring the distance between the head and the neckline (green line) , then copy-pasting the same trendline starting from the neckline and extending lower. This way, you determine the exact point where the head and shoulders pattern should complete. Finally, our entry is at $1.2820 , stop loss is around $1.2860, while the take profit order is set at $1.2550. Therefore, we risked 40 pips to earn 270 pips, which is a phenomenal risk-reward ratio and the best evidence why the head and shoulders is an effective reversal pattern.

Trading Benefits Using Head and Shoulder Pattern

Both versions of the pattern have the same strengths and weaknesses, differing only in the context of their structure. Arguably, the biggest advantage of the head and shoulders pattern is that it defines a clear area to set risk levels and profit targets. Due to its design, the pattern offers clear stop losses, take profits, and entry levels. A trader should simply follow a set of rules (explained below) and ensure that they do not “jump the gun” and enter a trade before the neckline breaks. It is important to emphasize that both the reverse and traditional patterns only occur at the bottom of an uptrend or downtrend.

This is a common mistake that traders and analysts make. It doesn’t matter if you draw a perfect head and shoulders pattern, if there is no previous uptrend or downtrend because both versions are reversal patterns. Here’s why you should at least try trading the head and shoulders pattern:
  • This time-tested chart formation provides the most powerful reversal signals out there. Traders consider it to be one of the most reliable technical analysis patterns.
  • Head and shoulders can be used with any market and trading asset, including cryptocurrencies.
  • It is relatively easy to identify on a chart once you understand the elements and practice it a few times.
  • This pattern has well-defined risk and profit levels, which is excellent for beginners.
After learning about the head and shoulders pattern, its characteristics, how to read, and examples of patterns regarding this pattern itself, then make sure you choose the right action when dealing with this pattern itself. In addition, you can also read other pattern articles such as Characteristics and How to Trade Using Spinning Tops Candles.