A Head and Shoulders reversal pattern

The 90 day challenge has been off to a good start, today we noticed some head and shoulder patterns on the short term chart and I would like to discuss this pattern.

The Head and Shoulders pattern

This pattern is a great one to discuss because its a very popular one for this reason, I am extra careful to jump into this pattern since many traders know about it.  The Head and Shoulders is a pattern that forms after an uptrend, and its completion marks a trend reversal. The pattern contains three peaks, the head being the highest and the two outside ones being lower and not always equal. The lows of each peak are called the neckline.

The Head and Shoulders reversal pattern is made up of a left shoulder, a head, a right shoulder, and a neckline. Other parts playing a role in the pattern are the volume. Since the Forex market does not have a central exchange we will not use this as we cant accurately track this, if you were dealing with stocks you, that would be a different story.

To be a Pattern please read below to be sure the pattern matches.

1. Was their a Prior Trend?: It is important to establish the existence of a prior uptrend for this to be a reversal pattern. Without a prior uptrend to reverse, there cannot be a Head and Shoulders reversal pattern/

2. Left Shoulder?: While in an uptrend, the left shoulder forms a peak that marks the high point of the trend. After making this peak, a decline will follow.

3. Head?: From the low of the left shoulder, an advance begins that exceeds the previous high and marks the top of the head. After peaking, the low of the subsequent decline marks the second point of the neckline (2). The low of the decline usually breaks the uptrend line, putting the uptrend in jeopardy.

4. Right Shoulder?: The advance from the low of the head forms the right shoulder. This peak is lower than the head (a lower high) and usually in line with the high of the left shoulder. While symmetry is preferred, sometimes the shoulders can be out of whack. The decline from the peak of the right shoulder should break the neckline.

5. Neckline?: The neckline forms by connecting low points 1 and 2. Low point 1 marks the end of the left shoulder and the beginning of the head. Low point 2 marks the end of the head and the beginning of the right shoulder. Depending on the relationship between the two low points, the neckline can slope up, slope down or be horizontal.

6. Price Target: After breaking neckline support, the projected price decline is found by measuring the distance from the neckline to the top of the head. This distance is then subtracted from the neckline to reach a price target. Any price target should serve as a rough guide, and other factors should be considered as well.

As I mentioned in the start of this article head and shoulders pattern is one of the most common reversal formations. While it is preferable that the left and right shoulders are levels they can sometimes have one shoulder higher or lower than the other one.  They can be different widths as well as different heights. Identification of neckline support and volume confirmation on the break can be the most critical factors. The support break indicates a new willingness to sell at lower prices. The head and shoulders pattern is a pattern that we use in our Forex Trading Room and call this pattern out regardless if we are taking a live trade.