Among classic technical analysis pattern, the head and shoulder chart pattern stands out of the crowd. A head and shoulders chart is a reversal pattern that allows incorporating both price and time in an analysis.
I wanted to get your attention from the first paragraph. Reread it!
What’s unusual? Price and time.
In Forex trading, there’s no such thing as a holy grail. Namely, no one setup or pattern works one hundred percent of occasions.
However, there’s consensus regarding what comes close to the holy grail in trading. Again, that’s price in time.
More exactly, knowing where the price goes is one thing. However, if you can tell when it will go to that target, that’s jackpot.
In many cases, time is more valuable. At least, that’s true in Forex trading.
Think of it. What if I told you the market still needs time to consolidate for a while? That is, before breaking the range.
As such, armed with this info, you’ll avoid blocking margin in that trade. Moreover, avoid paying potential negative swap. And, you’ll wait until the market moves.
However, few know how to trade it. Besides the classic interpretation, traders forget the actual use of the head and shoulders pattern.
As such, we’ll deal here with advanced techniques to read the head and shoulders chart pattern. We’ll cover:
- The textbook head and shoulder chart pattern
- Head and shoulders as a trend reversal pattern
- How a head and shoulders chart pattern looks on real Forex charts
- Step-by-step advanced approach to trading with the head and shoulder chart pattern
- Pros and cons of using the head and shoulders chart
- Tips and tricks for using the head and shoulder forex pattern
Textbook Material for Head and Shoulders Chart Pattern
Earlier I hinted at the power of a head and shoulders chart. It is a wonderful way to time a market. And, a way to make some pips.
Before anything, we should start from the scratch. Namely, from what every retail trader knows.
Afterwards, we’ll look at a different way to interpret the pattern. Or, at an advanced, step-by-step approach.
When you think of a head and shoulders chart, think of a real person. That is, the pattern is inspired by the human body’s parts.
Namely, a head and shoulders chart pattern has:
- A head
- Two shoulders
- A neckline
As humans, we all have a head and two shoulders. In technical analysis, the line that defines the two shoulders is the neckline.
The image above shows the textbook material for the head and shoulders pattern Forex traders use. On top of the elements described, the pattern has a measured move too. More on that, a bit later.
Traders won’t know the pattern will form. That is, they won’t know the head forms.
A false move represents the pattern’s head. Namely, a spike higher followed for a quick retracement at the original level.
Or, if the market forms an inverse head and shoulders, the head shows a different move. Yet, a fake one.
A move lower quickly followed by a move higher, represents the head. From this moment, traders have a hunch a reversal pattern follows.
Why a reversal pattern? Because the head and shoulder chart pattern is a reversal one, above all.
Head and Shoulder Chart Pattern at the End of a Trend
That’s the real meaning of a head and shoulders pattern. To reverse a trend.
As such, traders pay attention to the trend’s strength. And, to the time frame.
This is a compelling statement. For if there’s no trend, the market forms something else. Not a head and shoulder chart pattern!
Hence, for a head and shoulder chart pattern, we need:
- A bullish trend.
- A consolidation close to the top
- One quick, explosive move higher, followed by a quick retracement at the original breakout point
- Another consolidation at the same level
On the other hand, an inverse head and shoulders pattern:
- Forms at the end of a bearish trend
- A consolidation close to the bottom forms
- One aggressive selloff follows, only for the price to quickly retrace to its starting point
- The market consolidates for a while at the same level
Classic Interpretation of the Head and Shoulder Chart Pattern
As mentioned earlier, the pattern comes with a measured move. That’s both a blessing and a curse.
It’s a blessing because it gives a price target. And, if the head and shoulder chart pattern forms on bigger time frames, that’s quite something.
However, the measured move is merely an indication. It often happens that traders:
- Set the take profit at the projected measured move
- The market hits the level
- Traders enjoy the moment
- Only to see the price keeps going and going
In other words, it is a curse as traders may end up exiting too early. Here’s the measured move:
Traders engage in several steps. First, they draw the neckline. That is the line that marks the consolidation area of the two shoulders.
Second, they measure the void/empty space between the neckline and the top of the head. That’s the measured move.
Finally, they project it from the neckline. And, that’s the take profit.
Conservative traders wait for the price to retest the neckline. That’s what the above images show too.
However, in real-life Forex trading, a head and shoulders chart may do that. Or, it may not!
But how is a head and shoulders chart pattern looking on the Forex market?
Head and Shoulders Chart on the Forex Market
Today’s Forex market represents the one financial market in constant change. Technology advances so fast that everyone needs to keep up with the pace.
Forex brokers need to update their offering with new technology. We take for granted the ECN (Electronic Communication Network) and STP (Straight Through Processing) technologies.
But, they appeared only a few years ago. As a broker, either you adapt, or die.
Traders must adapt too. Patterns change. How come?
That’s easy to answer. With improved technology, comes better execution.
And, with better execution, patterns change as price moves faster. While, at the same time, being more accurate.
Earlier it was mentioned that the head and shoulders chart belongs to Western technical analysis approach. However, that’s not something to brag with.
For most of those patterns were discovered on the stock market charts. Moreover, this was a long time ago.
Or, conditions differed. Both from the market’s perspective, as well as from the execution point of view.
Nowadays, a head and shoulders chart pattern looks different. Here’s an inverse head and shoulders pattern on the EURUSD pair.
What’s different? Firstly, the neckline isn’t horizontal. Does this invalidate the pattern? No.
Secondly, the head isn’t quite proportionate. Does this invalidate the pattern? No.
However, it still has all its original elements. Traders must simply learn an advanced way to read it.
Step-By-Step Advanced Read of Head and Shoulder Chart Pattern
Enough with the suspense. You have an idea about a typical head and shoulders chart on the Forex market. If not, check the EURUSD from above.
Here’s a step-by-step approach to how to trade it. This advanced technique works on all time frames. And, all currency pairs.
If you follow these steps, you’ll have a competitive advantage ahead of other market participants. Isn’t this what every Forex trader wants?
We’ll use the EURUSD previous chart to build the trading system. Just make sure you follow step-by-step the upcoming guide.
The Neckline of a Forex Head and Shoulder Chart Pattern
It all starts with the neckline. How come?
Remember what was said earlier? The head and shoulder pattern becomes visible only after the head forms.
Until that moment, everything is a blur. Just regular candlesticks, without a particular pattern. Providing you spot the head, the next thing you know, you can use this approach.
Of course, this is true if you have enough time to react. As if you trade a head and shoulders pattern on the five-minute chart, you may miss it.
In this case, we’ll continue the weekly EURUSD pattern. The previous head and shoulders chart showed the consolidation on the left side (left shoulder). Next, a quick move lower. Finally, the price retraced to approximately the same level.
That’s all we need. What next?
The neckline. As we must draw it in a particular way.
Therefore, look for the following. First, don’t look for it to be horizontal. On the Forex market, that rarely happens.
Second, avoid the candlesticks’ shadows. They don’t reflect the correct move. Stick to their bodies.
As such, draw the neckline from the upper part of the bodies at the start of the left shoulder. And, connect it with the top part of the bodies on the right shoulder.
Just like in the chart above. That’s the right way to draw the neckline.
Project the Inverse Head and Shoulders’ Neckline
Now that we have the neckline, it is time to do something with it. The next step is to project it.
But, where? Definitely, towards the head. Why?
That’s easy. We want to find out future support levels for the price.
That is, during the right shoulders formation, the projected neckline serves as a support. Or, a beautiful place to trade during right shoulder’s consolidation.
However, use the same rule as the earlier one. Namely, project it from the candlesticks’ bodies. Not from their shadows.
The head and shoulders chart below shows the projected neckline. As you can see, at the end of the right shoulders consolidation, the price found support on it.
Isn’t that a great place to go long? But, that’s not all. In fact, that’s only the start.
Use the Time Element in an Inverse Head and Shoulders Pattern
Sometimes, time is more important than price. That’s especially true in Forex trading.
For this pattern, you should start from what you already know. Well, that’s the left shoulder.
Look at it and take as much information from it. For the more the left and right shoulders resemble, the more powerful the head and shoulders chart becomes.
As such, only measure the time taken for the left shoulder to hold. More precisely, draw a vertical line from the start of its consolidation.
Next, take a shape and mark the area. Finally, draw another vertical line. Just like below.
Now that we calculated the time, we can use it. Therefore, project it from the first candle that reaches the neckline. That is, on the right shoulder, of course.
The pattern should look like above. See the similarities between the two shoulders?
Now, let’s go back to the rule of thumb. The more they’re alike, the stronger the pattern is.
Keep in mind this is the weekly time frame. As such, there’s no excuse for missing this excellent head and shoulders chart.
Correctly Use the Measured Move
This is where rookie traders fail most. They don’t know how to draw the measured move.
Of course, there’s a catch. The textbook condition you saw earlier.
But, real life charting differs. Here’s the rule:
- Draw the measured move to measure the void. That is, the empty space between the:
- And the head.
However, that’s not it. Moreover:
- Measure that distance in such a way to obtain a ninety-degree angle on the neckline.
Use the EURUSD weekly head and shoulder chart pattern below as an example. Where’s the catch?
It differs in many ways. First, the measured move is shorter. Or, more accurate.
Second, when projecting it, the distance is smaller too. Hence, the price has more chances to reach it.
This may not seem as important but look at the time frame. The difference is of a few hundred pips. It matters!
Finally, it’ll give an estimated angle of the future price action. For the more inclined the measured move is, the less aggressive the new trend will be.
Trading the Neckline’s Retest
Before anything, the neckline’s retest isn’t mandatory. For those that claim it is, you can simply ignore that.
However, if the price retests it, use that. But, only if the retest comes before the price completes the measured move.
In the example below, the time on the right shoulder expires. Next, the price exploded higher.
But, it was no retest. However, neither the measured move was completed.
The price missed it by an inch. Many would consider the head and shoulder chart pattern finished.
That’s wrong. It’ll become complete only when the price travels the distance. In this case, it didn’t.
Moreover, the price turned South. In a painful move for the bulls, it fell for more than seven weeks.
Even the stronger bulls will have their confidence shaken. Yet, smart traders will use this move lower as an opportunity.
That is, an opportunity to buy. Where? At the neckline’s retest, of course.
How about the target? That one didn’t change. It is the old measured move. Only this time, the price did travel the whole distance.
Allow me to suggest the following. Find the EURUSD weekly pattern on a naked chart.
It should be an easy task. Next, look at the candlesticks. You may not see the inverse head and shoulders pattern. That’s ok.
Finally, compare the naked chart with the one above. Only now, you see the real power of the head and shoulders chart pattern.
The actual head and shoulder chart meaning is to reverse a trend. While the example used in this article might be enough for some traders, it represents the minimum setup.
However, because of the time frame, it showed a hefty profit. But something else is more important.
And that is, the way to trade the pattern. It is a disciplined approach that leaves little or no room for error.
Such a head and shoulders chart will keep you on the right side of the market. That’s not valid only on the EURUSD pair.
But, if you have an idea where the EURUSD pair goes for the weeks ahead, you know where the dollar will go.
Therefore, you can adjust your exposure on other currency pairs too. Hence, a simple pattern may influence the analysis on other currency pairs too.
The idea behind this article was to present a different way to look at the head and shoulder chart pattern. Because it forms very often, it is important to understand how to trade it.
Before that, however, you must know how it forms in real-life trading conditions. And that is what we’ve tried to show here.
When compared with Japanese candlestick reversal patterns, there are no trend reversal indicator mt4 platform offers. Even though, in time, many attempts existed.
The reason for that is simple. While the Japanese reversal patterns have clear rules that involve a few candles, the head and shoulders chart is constantly changing.
On some pairs, it looks like textbook material. On others, it looks gruesome.
However, a disciplined approach works every time. Try to use it with a realistic risk-reward ratio, and you’ll be on the safe side.
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