Head and Shoulders

Head and Shoulders

Head and Shoulders is a well-known chart pattern used in technical analysis to predict changes in a security’s price trend. It is typically identified when a security’s price rises to a peak (the left shoulder), then falls, and then rises to a higher peak (the head), before falling again. Finally, the price rises once more, but to a level lower than the head’s peak (the right shoulder).

Key Points

– The Head and Shoulders pattern is considered a reversal pattern, indicating a potential change in the current price trend.

– To confirm the pattern, traders look for a significant decrease in volume during the right shoulder formation.

– The pattern is complete when the price falls below the neckline, a support level formed by connecting the lows of the left and right shoulders.

How to Use Head and Shoulders

Traders use the Head and Shoulders pattern as a signal to sell or short a security, with the expectation that the price will continue to decline after breaking below the neckline. Some traders may also use the pattern as a signal to initiate a long position once the price breaks above the neckline in a reversed Head and Shoulders pattern.

Limitations of Head and Shoulders

While the Head and Shoulders pattern can be a powerful tool for predicting price reversals, it is not foolproof. False signals can occur, leading to losses if trades are made based solely on the pattern. Additionally, the pattern can take time to develop, so traders must exercise patience and wait for confirmation before making trading decisions.