Head and shoulder patterns occur in all time frames and are visible visually. Although sometimes subjective, the complete pattern provides entry, stop, and profit targets, facilitating the implementation of trading strategies. The pattern consists of the left shoulder, head, and right shoulder. The most common starting point is the neckline break, which stops above (market top) or below (bottom market) on the right shoulder. The profit target is the difference between the highest and lowest prices when the pattern is added (market bottom) or subtracted (market top) from the breakout price. This system is not perfect, but it does provide a way to trade the market based on logical price fluctuations.
Why do the head and shoulder patterns work?
There is no perfect pattern and it doesn’t work every time. Still, there are several reasons why chart patterns work theoretically (market top is used for this inference, but both are true).
- As market prices fell to highs (heads), sellers began to enter the market and were less aggressive in buying.
- As the neckline approaches, many people who bought higher in the previous wave at the rally or bought on the right shoulder are now wrong and are facing huge losses-close the position and profit from the price. It is this big group that pushes towards. ..
- The stop above the right shoulder makes sense because the trend is shifting down (the right shoulder is lower than the head).
- Therefore, the right shoulder is unlikely to break until the uptrend resumes.
- The profit target assumes that the person who bought the security at the wrong or bad time is kicked out of the position and creates a reversal of the same magnitude as the topping pattern that just occurred.
- The neckline is the point where many traders experience pain and are forced to close their positions, pushing prices towards price targets.
- You can also view the volume. With the opposite head and shoulder pattern (bottom of the market), ideally, we would like to increase the volume in the event of a breakout. This shows that buying motivation is increasing and prices are moving towards the target. The decrease in volume indicates a lack of interest in an upward movement, justifying skepticism.
Pit of head and shoulder trading
As mentioned earlier, the pattern is not perfect. The potential problems when the trading head and shoulder patterns are:
- You need to find the patterns and see how they evolve, but don’t exchange this strategy until the patterns are complete. Therefore, it can mean a long wait time.
- It doesn’t always work. You may reach the stop level.
- Since profit targets are not always achieved, traders may want to fine-tune how to market variables affect their withdrawal from securities.
- Patterns are not always negotiable. For example, if one shoulder drops significantly due to an unpredictable event, the calculated price target will probably not be met.
- The pattern can be subjective. One trader can see the shoulders that the other trader cannot see. When trading a pattern, follow the general guidelines above to predefine the pattern.
