Technical Analysis - Head and Shoulders
As we already stated, understanding chart patterns is fundamental to gather information and to ensure good conditions for future trades. For obvious reasons, the head and shoulders patterns are also known as “shampoo” patterns, however, how could you possibly identify a head and shoulders formation in your chart? The name says it all, whenever you see that the stock price increases to a peak that declines straightway (the first shoulder), then increases again at a higher point (the head) and immediately declines. The line of the price finally increases to a peak (the second shoulder) that is very similar to the first peak. At that point, you are watching a head and shoulders pattern, like the one on the chart above.
Tips for identifying chart patterns
The most important fact to bear in mind, is that you should try to identify these patterns on real-time, so that they can become a significant strategy. In order to achieve this, there are a few tips we, together with authors of the best Forex books would like to share with you:
» Pay attention to the neckline or bottom line
Keep in mind that the neckline is your support level, not necessarily a straight line, but an ascending or descending one. On the other hand, you should be aware of the amount of pips from the top to the neckline, which is your range of movement. A broken neckline is a clear appeal for you to place orders and sell.
Note: It is advisable to hold a pullback and perform a retest of the neckline.
» Keep an eye on indicators such as Stochastics and RSI
Whenever the volume is low at the point of the second peak (the head), it means that buyers took a weak chance on the upside. A lesser volume means that prices will decrease, so you will have fewer opportunities to push for earlier highs.
Note: Stochastics and RSI produce overbought signals; in that case, it is advisable to place orders and to place a stop above the head.
» Look for the volumes
Try to look for the volumes. As the volume declines with each peak, being aware of the volume will allow you achieve an early recognition of any head and shoulders pattern.
Note: Keep in mind that it is not always the case.
» Identify the inverse head and shoulders patterns
The inverse head and shoulders (upside-down direction) patterns may appear in your chart too; in that case, you must follow the same instructions, but just the other way around.
Note: Bear in mind that the inverse head and shoulders pattern also comprises straight, ascending and descending lines, and the neckline is a support level too. The most advisable move here is to try and buy upon the break of the neckline.
» Remain resilient
The last and best advice of all is to remain resilient and well founded if you want to achieve some positive results in your trading activity.
To sum up, if you are able to identify chart patterns earlier, you can reduce risks and get the most out of the profits. Although it is not a strategy itself, it definitely helps to clear the picture and increase our predictability chances for the near future. Like many other indicators, if identified and applied successfully, you can ride the head and both shoulders on earnings.
Updated on 5. December 2019
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