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Pattern

Pattern Formation​

The Head and Shoulders pattern is a reversal pattern that signals a potential change in the prevailing trend. It consists of three peaks: a higher central peak (the "head") flanked by two lower peaks (the "shoulders"). The pattern is completed when the price breaks through the "neckline," a support or resistance line connecting the lows (in an uptrend) or highs (in a downtrend) of the two shoulders.

In an Inverse Head and Shoulders pattern, the formation is flipped upside-down. The central trough (the "head") is the lowest point, while the two shoulders form higher lows. The neckline connects the highs of the shoulders and acts as the breakout level.

Key Components​

  1. Left Shoulder: The first peak (or trough) forms as the price rises (or falls) and then retreats.
  2. Head: The central and most prominent peak (or trough) forms as the price attempts another move higher (or lower), surpassing the level of the left shoulder.
  3. Right Shoulder: The price forms a lower peak (or higher trough) relative to the head, signaling waning momentum in the prevailing trend.
  4. Neckline: A trendline connecting the two reaction lows (or highs) of the shoulders. A breakout above (or below) this line confirms the pattern.

Volume​

Volume plays a critical role in confirming the pattern. During the formation:

  • Volume often diminishes as the pattern develops, reflecting declining interest in the existing trend.
  • A significant increase in volume on the breakout through the neckline strengthens the validity of the reversal.

Breakout​

The breakout occurs when the price breaches the neckline after forming the right shoulder. The direction of the breakout determines the pattern's implication:

  • Head and Shoulders: A breakout below the neckline signals a bearish reversal, often indicating the start of a downtrend.
  • Inverse Head and Shoulders: A breakout above the neckline signals a bullish reversal, suggesting the onset of an uptrend.

Target Projection​

To estimate the price target following a breakout:

  1. Measure the vertical distance between the head and the neckline.
  2. Project this distance from the breakout point in the direction of the breakout.

Trading Implications​

Traders use the Head and Shoulders pattern to identify entry and exit points, place stop-loss orders, and forecast price targets. It is commonly used in combination with other technical indicators or patterns to confirm the breakout and increase the likelihood of a successful trade.

tip

Explore our Combinations section for ideas on combining the Head and Shoulders pattern with tools like Trend Bars Pro or the Swing Suite for enhanced trading strategies.