The Head and Shoulders Pattern is a trend reversal pattern consisting of three peaks. The two outside peaks are in the same height, while the middle one is the highest. The pattern identifies a bullish to a bearish trend reversal and emerges in an uptrend.
What is the Head and Shoulders Candlestick Pattern?
The formation of the pattern is based on a peak (shoulder), followed by a higher peak (head), and then another peak (shoulder). The two shoulders symbolize right and left shoulder. A neckline can be drawn by joining the lowest points of the two troughs (a stage which tells the prices are declining before rising again).
The Head and Shoulders describes that the price hurries its way to the top but then declines. After that, the price rises again but is higher than the previous level, then drops back. Finally, the price climbs up again but equal to the first peak’s level and then declines back.
Here’s what the Head and Shoulders Candlestick Patternlooks like on a chart:
The opposite of the Head and Shoulders Pattern is the Inverse Head and Shoulders. It appears in a downtrend and signals a reversal from the bearish pattern to a bullish pattern.
Sometimes when the Head and Shoulders Pattern is present, the price breaks through the resistance level, indicating a bearish pattern, it is known as a double top. It finds its way in an uptrend and breaks a neckline formed by the Head and Shoulders Pattern. This tells us that a trend reversal is near. The Double Top looks similar to the alphabet M.
How to use the Head and Shoulders Candlestick Pattern?
It is pertinent to wait for the Head and Shoulders Pattern to complete its construction. This is because a partially developed pattern may not complete in time.
An entry is usually considered when the pattern breaks the neckline (level of support and resistance, determining areas of placing orders).
A short trade is made right after a formation of the right shoulder. The stops can be placed above the right shoulder. Alternatively, the head can be used as stops.
The Head and Shoulders Pattern has a few limitations. It doesn’t give a clear picture about the bullish or the bearish trend. When one peaks forms, the price declines. But then, the bulls push the price up again, forming a middle peak before the bears retake control. Bulls push the price one more time, creating a new peak, but afterward, the bears take over, completing the reversal.
These highs and lows are confusing for some traders, and sometimes there is a significant drop in price on one of the shoulders. Besides this, the Head and Shoulders Pattern can take a long time for its appearance.
Head and Shoulders Candlestick Pattern trading strategy
The Head and Shoulders Pattern can be spotted on all timeframes and be used for entry, exit, and stop-loss if implemented within a forex trading strategy.
However, I find it works better when combined with other technical analysis, fundemental analysis and sentiment analysis.
As the candlestick pattern is a transformation of bullish to bearish, it only provides sell signals. They can appear on forex currency pairs, stocks, indices, cryptocurrencies, commodities, metals, energies, gold, silver and more.
Head and Shoulders sell strategy
- Wait for the completion of the pattern.
- Wait for the price bar to go bearish before entering.
- Enter after the formation of the right shoulder.
- Place a stop-loss near the high from the right shoulder.
- Exit the trade when the price rises.
Head and Shoulders Candlestick Pattern conclusion
The Head and Shoulders Candlestick Pattern can be used on your trading platform charts to help filter potential trading signals as part of an overall trading strategy. The Head and Shoulder Pattern illustrates the movement of the price and can help to spot potential reversal trades. Yet, the pattern has some drawbacks. Therefore, when trading the pattern, it can be used with other technical indicators.
I would prefer to use the majority of candlestick patterns such as the Head and Shoulders Candlestick Pattern on the 1-hour charts and above. I tend to find that these charts contain less market noise than the lower time frames and thus give more reliable signals for my forex trading strategies. This also means that I spend less time staring at charts and can also set alert notifications to let me know when price has reached certain levels, candlestick pattern has been formed or a particular indicator value has been reached.
The Head and Shoulders Candlestick Pattern is just one method of market analysis amongst thousands. I would not build a trading system alone, but rather combine with other technical indicators such as moving averages, Parabolic SAR, Stochastic Oscillator, RSI, ADX and price action analysis.
Of course, every trading system will generate false signals which is why money management is so important. I would personally be implementing sensible money management and only take traders that give me a favorable risk to reward ratio, ideally of at least 1:3. This means that one losing trade does not wipe out consecutive winners.
The methods of implementing the Head and Shoulders Candlestick Pattern into a trading strategy that are outlined within this article are just ideas. I would always ensure that I have good money management, trading discipline and a trading plan when using any forex strategy.
Furthermore, I would combine multiple technical analysis, fundamental analysis, price action analysis and sentiment analysis to filter all entries. You should trade forex in a way that suits your own individual style, needs and goals.
If you would like to practice trading with the Head and Shoulders Candlestick Pattern, you can open an account with a forex broker and download a trading platform. If you are looking for a forex broker, you may wish to view my best forex brokers for some inspiration.