What is a head and shoulders pattern?
A head and shoulders
pattern is a signal for a big move lower. It shows you when a bullish trend is about to change into a bearish trend.
What’s useful about the head and shoulders pattern is you get a clear sell signal and you can get a good idea of how much the price will fall by.
The five stages of a head and shoulders pattern
This happens when a strong rise in price comes to a halt. The price hits resistance and pulls back.
This forms the left shoulder on our head and shoulders pattern.
The price starts to rise again. It hits a new high (in comparison to stage one).
This forms the head on our head and shoulders pattern.
The price pulls back again after hitting a high. The price falls more this time. This shows that investors are becoming a bit worried and sellers are pushing the price down.
Then a small rally occurs, probably on lower volumes. This move gives you the right shoulder.
Now you have both shoulders and the head on your pattern, you can draw in the neckline.
The neckline is a very important aspect of a head and shoulders pattern
A neckline runs from the bottom of the left shoulder to the bottom of the right shoulder, Frank Hemsley in Profit Watch
The neckline is important as you can use it to measure how far a price should fall.
Once you have confirmation of a head and shoulders pattern, after the last rally the price falls. This time, the price falls through the support level at the neckline. This tends to happen on heavy volume.
If you measure from the peak of the head to the neckline, this tends to indicate how much the price will fall below the neckline.
By spotting head and shoulders patterns, you can make hefty short-term profits from shorting. And you can sell out of long trades you’re in if you spot a head and shoulders pattern too to preserve your profits.
So there you have it. How to use this trading pattern to generate profitable trades.
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