Head and Shoulders Pattern

The head and shoulders chart pattern is a predictive chart formation. It typically signals a trend reversal or a change in the market's outlook from bullish to bearish or vice versa. For a long time, this pattern has been useful to accurately forecast trend reversals. However, it is crucial to remember that the head and shoulders pattern is not error-free. This means there will usually be slight price changes between the head and the shoulders, and the pattern formation is rarely precisely shaped. In this blog, we’ll learn about what is head and shoulders pattern, inverted head and shoulders pattern and more.

How does the Head and Shoulders Pattern Work?

The head and shoulders pattern is quite effective. Let’s look into some of the methods that explain how it works:

1. Recognise Market Trend: You can create a strategy more rapidly if you identify the trend early on. In addition to helping you identify low-risk trade situations, you'll have a general idea of what the stock is doing.
2. Arrange Your Entry and Prevent Losses: When your thesis is supported by the price action, it is better to enter a trade. That might occur when the stock shows a price surge on higher volume or breaks out of a critical level. Additionally, you want to set your stops at reasonable prices. perhaps above a significant swing high or below a prior support level.
3. Establishing Your Profit Objectives: Make sure you're not only trading on feelings at random, regardless of the approach you choose. You may wait for the stock to test a significant round-number level, like Rs.10 or 20, or wait for it to retest a prior high. A stock's trading range can also be examined and used to forecast future price movements.
4. Examine the Volatility and Volume: How many shares are traded in a certain period is known as the trading volume. It allows you to determine if there are enough buyers and sellers to move into or out of a position with ease. Knowing if a price swing is significant or only a random movement can also be helpful. 
   The amount that a price fluctuates over a given period is known as price volatility. Certain equities frequently experience daily movements of 5%, 10%, or more. Others can see a price change of just 1% in a single trading session. 
5. Observe the daily and weekly deadlines: On long-term charts, such as daily or weekly bars, the head and shoulders pattern is typically most helpful. This is due to the fact that this pattern can be used to identify a significant shift in trend. For the price pattern to unfold, you want a lot of traders to see it and respond appropriately.

Example of Header & Shoulders Pattern

An example of a head and shoulders pattern that appeared on a candlestick chart is provided below. The security fell through the neckline after forming the left shoulder, head, and right shoulder, indicating that it would keep falling. The right shoulder is quite small in this specific case. There was a lot of selling pressure before the collapse, as shown by the price's inability to recover much toward the head. This pattern is known as a head and shoulders top chart. 

Note: We will be needing the image to explain the example.

How Reliable is a Head and Shoulders Pattern?

The most commonly used entry point is a neckline breakout that ends either below the right shoulder (market bottom) or above it (market high). The difference between the breakout price and the low and high points is the profit target when the pattern is added (market bottom) or subtracted (market top). 

Can Head and Shoulders Turn Bullish?

An inverse head and shoulders pattern, sometimes referred to as a "head and shoulder bottom," is an inverted version of the classic head and shoulders pattern, with the head and shoulder top being used to forecast downtrend reversals. This indication swings from bullish to bearish.

How to Trade Using a Head and Shoulders Pattern?

Let’s now learn how to trade using a head and shoulders pattern. 

• Be sure that before you start trading the pattern, the pattern formation is complete.  
• Before getting in, you must wait until the neckline breaks. If you begin the pattern too early, it might not develop or run through its whole course. 
• After the peak of the right shoulder, you're waiting for the price to drop below the neckline.  
• Ensure that you record the entrance, stops, and profit goals. Any reasons that will alter your price objective should also be noted.

Inverse Head and Shoulders Pattern

At market bottoms, the inverted head and shoulders pattern forms: 

• Left shoulder: A price bottom, a price decrease, and a price increase
• Head: The price drops once again, creating a lower low.
• Right shoulder: The price rises once more before falling to create the right bottom. 

There can be some market noise between the corresponding head and shoulder.

Advantages and Disadvantages of the Head and Shoulders Pattern

Let’s look into the advantages and disadvantages of the head and shoulders pattern.

Conclusion
Head and shoulders patterns occur across all markets. It consists of a head, a left shoulder, and a right shoulder. The most common entry opportunity is a neckline breakout with a stop above (market peak) or below (market bottom) the right shoulder. When the pattern is added or subtracted, the profit is the difference between the breakout price and the low/high points. Although this strategy isn't perfect, it offers a structured approach to trading the markets based on reasoned price changes. You can use a reliable stock market app to trade the pattern alongside other indicators for more accuracy.