Head and shoulders pattern ~ forex trading business plan
Head and shoulders is the topic of the post. Those who have any understanding about technical analysis definitely know what it is. Let me talk a little bit on the theme. I will give you a chart first and some theoretical and practical points later.
Head and shoulders definition
As you may see head and shoulders pattern is a reversal pattern that usually happens after a prolonged uptrend or a swing. It consists of three highs: left shoulder, head and right shoulder. The structure is joined by a neckline that constitutes support.
How is head and shoulders pattern formed?
This works best on longer term charts. Firstly, there should be an uptrend in place for the pattern to be as effective as possible. After a prolonged uptrend prices may start going kind of parabolic and suddenly collapse. This helps to form the left shoulder and the point for a neckline. Then uptrend resumes and prices go beyond previous highs (left shoulder). Then security collapses again and lands somewhere near previous support. Security rallies for the last time and finds resistance lower than the head is and collapses again. This time, it goes beyond support and a downtrend begins. If the security is not able to break the neckline, the pattern is usually distorted and the security either starts going sideways or resumes its’ upward trend.
How to trade head and shoulders pattern on daily and weekly charts
On daily charts the pattern can be very big, stretching from three months to one year or sometimes even more. So, one has to be pretty patient waiting to see possible place of entry. In fact it is much better to spot those patterns on weekly charts (if we have in mind reversal that happens after a very long uptrend is finished).
To tell the truth one can never be sure if one is looking at a real head and shoulders pattern or simply a pattern which looks like the real one. Difference between real one and a fake one is not very big. The real one is fulfilled, the false one is not. The real one is fulfilled when the price after having formed the right shoulder collapses through the neckline. That the only way to know whether the pattern is the true one or a false one. You have to wait for a collapse through the neckline. So, the best way to trade it is to place a sell stop order below the neckline and go short when the prices go beyond the level.
