When you read the words head and shoulders pattern, what comes to mind? Of course, it has to be charts. It could be any along with a wide range of options.
The steady movement of values up and down continuously over a period of time would create the pattern. The market was steady and then suddenly experienced a spike, followed by a reversal and then a huge spike followed by another huge reversal which is also accompanied by a spike.
The extent to which the values spike would be the determinant of if it’s to be called a head and shoulders pattern or just a random pattern that emanated from price spikes.
This article is about patterns, the head and shoulders pattern, and what you can do with them. This is to help you understand the same way professionals use it and how it can help you when you choose to use it.
To build an investment portfolio by just holding or trading stocks, cryptocurrency, and other assets which can be just about anything, it can sometimes be important to educate yourself on the likely events that cause the swings you are sometimes very scared of.
In the likely event that a head and shoulders pattern emerges, to the uninitiated, the only thing you see is that the value of your asset dipped, later rose again, and maybe performed this dipping and rising a couple of times before stabilizing.
While you may be worried, it is a joyous event for both you and the trader who knows what is about to happen next. Which is that things are about to normalize in terms of both price action and volume.
A head and shoulders pattern is nothing terrifying but can serve as many things to many people, it all depends on who is reading the charts and if the pattern appears in a bullish way or a bearish way.
What is a chart?
Technical analysts use charts as their primary tool. They plot the price fluctuations of a stock over certain time frames using charts. It’s a graphical representation of how stock prices have changed over time.
A chart depicts a stock’s price history over time, whether it’s an hour, day, week, month, or many years. It features a horizontal x-axis and a vertical y-axis (vertical). The x-axis is usually used to indicate time, whereas the y-axis is used to represent price.
By graphing a stock’s price over time, we may provide a visual picture of the stock’s trading history. A chart can also show the history of a stock’s trading volume.
Charts, or graphs as we call them, are used for more than only representing numerical data, as we may have learned in school. These are useful in a variety of other scenarios.
Let’s say we need to illustrate the proportion of students in a class’s marks or attendance in a visual fashion. Pie charts will be an excellent approach to demonstrate this.
You may use a pie chart to represent one student’s marks for each topic, or you can use a pie chart to represent each subject, with the slices representing the students’ marks. A bar chart might be a useful option if the number of pupils is large and a chart appears tough to construct.
What is a head and shoulders pattern?
A head and shoulders pattern is a chart formation that looks like a baseline with three heights, with the outside two being near in height and the middle being the highest.
A head and shoulders pattern is a technical analysis pattern that illustrates a detailed chart development that predicts a bullish-to-bearish trend change.
The head and shoulders pattern is considered to be among the most reliable pattern reversal patterns. It’s one of a variety of top patterns that, to varying degrees of accuracy, indicate when an upward trend is about to terminate.
Investopedia defines technical analysis patterns such as the head and shoulders pattern as “distinctive formations created by the movements of security prices on a chart and are the foundation of technical analysis. A pattern is identified by a line that connects common price points, such as closing prices or highs or lows, during a specific period of time.”
This, for the beginner, means that those dots you see connect for long enough to create the patterns that you are interested in are the price action points that the market decided on during those periods.
As things continue to progress, active members of the market continue to make decisions, and those decisions are still reflected in the price points and the kind of patterns that will be generated.
Types of head and shoulders patterns
There are two types of head and shoulders patterns to look out for and they are;
Bullish head and shoulder
The bullish pattern is usually found at the bottom of a decline, most especially when the decline starts to slow down. At this level, supply and demand are in equilibrium.
Buyers came in at the lows when prices reached a pivot low there. The left shoulder is formed as a result of this. The upside is tested sooner, and sellers return to the market, eventually pushing the market to new lows. The head is formed as a result of this.
The fresh lows, however, are rapidly reversed, and the upside is challenged once more. Tentative selling reappears, and the market continues to fall, but it fails to break through the previous bottom. The right shoulder is formed as a result of this.
Buyers return to the right shoulder’s low point and drive prices higher. The neckline for this design is a trendline that runs from the beginning of the pattern high after the left shoulder to the end of the pattern high after the head.
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Bearish Head and shoulder
The bearish pattern is mostly found at the top of a rally when the market is about to slow down and supply and demand are in equilibrium.
There was a pivot high there, and sellers entered at the highs. The left shoulder is formed as a result of this. The downside is explored sooner, and buyers return to the market, eventually pushing the market to new highs. The head is formed as a result of this.
The fresh highs, however, are rapidly reversed, and the downside is tried once again. Tentative purchasing returns and the market climbs again, but it falls short of the previous high. The right shoulder is formed as a result of this.
At the top of the right shoulder, sellers reappear and push prices down. The neckline for this pattern is a trendline that runs from the low created after the left shoulder at the start of the pattern to the low made after the head at the conclusion of the pattern.
How accurate is a head and shoulders pattern?
The head and shoulders patterns are the most statistically accurate of the price action patterns, hitting their forecasted objective over 85% of the time.
One of the most dependable trend reversal patterns is the head and shoulders pattern. It’s one of the numerous top patterns that, to varying degrees of accuracy, indicate the conclusion of an upward trend.
If you are one to pick patterns that have a proven record of turning out ell, then this pattern may just do you good, so it is important to look out for the pattern anytime it appears and then seize the opportunity when it arises.
Price action trading isn’t without flaws. There will be no trading technique or approach that is 100 percent accurate all of the time.
Price action tactics, on the other hand, have been found to be quite accurate, with many of the setups utilized by price action traders having a success rate of 75% or higher.
The head and shoulders (or inverted head and shoulders) setup is the most accurate trading pattern employed by price action traders. This setup is over 83 percent accurate in hitting expected targets when discovered and traded appropriately.
Bullish and bearish rectangles (almost 80% correct), as well as triple tops or triple bottoms, are other reliable setups (also nearly 80 percent accurate).
Mistakes most traders make when they see the pattern
- Measuring the head and shoulders pattern’s size: Traders frequently make errors in determining the true size of the head and shoulders pattern. The possible objective for the trade is directly proportional to the size of the Head and Shoulders formation.
- They believe that just because they see a head and shoulders pattern, the upswing will be reversed: The strong upsurge smashed a modest head and shoulders pattern.
- Recognizing a head and shoulders breakout in a timely manner: It’s always a challenge. When the price movement breaches the neckline downwards, open a short trade.
- Stay in the trade for a price movement of at least the size of the patter, which is the space between the tip of the head and the neckline.
What is technical analysis?
Technical analysis is a trading approach that predicts the market’s future using real-world data. It’s a way of assessing and forecasting cryptocurrency prices based on historical data, such as trade volume, circulating supply, and movement.
Investopedia describes it as a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activities such as price movement and volume.
It contradicts another common trading practice, fundamental analysis, in which investors examine and analyze a cryptocurrency’s intrinsic worth.
The price of a cryptocurrency is more important than the underlying value in technical analysis, and traders utilize charting tools to assess and analyze strengths and weaknesses.
Technical analysis is based on the idea that when it comes to an asset’s pricing or trends, history repeats itself. Technical analysts’ approach seeks to create forecasts about market psychology and cryptocurrencies based on this aspect.
Some of the concepts of Dow theory are used in technical analysis. Pricing on the market, for example, is said to represent everything, according to the theory. It might be anything: previous trends, current events, trader expectations, and so forth.
Technical analysis is likewise based on the belief that price movements are never random. Rather, these price changes are driven by short- or long-term patterns.
What is price action trading?
Price Action Trading is the practice of basing all of your trading choices based on a “naked” or stripped-down price chart. There will be no trailing indicators other than perhaps a couple of moving averages to assist identify dynamic support and resistance points as well as the trend.
All financial markets create data on a market’s price movement over various time periods, which is represented on price charts.
Price charts reflect the views and behaviors of all market players (human and machine) during a certain period of time, and these beliefs are shown in the form of “price action” on a market’s price chart (P.A.).
Using lagging price indicators like stochastics, MACD, RSI, and others is a waste of time because a market’s P.A. represents all elements impacting that market for any particular period of time.
All of the indications you’ll ever need to construct a winning and high-probability trading method come from price movement.
Price action trading methods are a collection of signals that assist you to make sense of a market’s price movement and anticipate its future movement with a high enough degree of accuracy to offer you a high-probability trading strategy.
An example of one of the derivates of price action strategy is the head and shoulders pattern.
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Many people observe a head and shoulders pattern when there isn’t one, and the dominant trend isn’t long enough to sustain the size of the head and shoulders.
Shoulders might be uneven, with volume confirmation lacking on counter-trend moves and, most critically, the neckline collapse.
In other words, many individuals see what they want to see rather than what is truly there, and any of the patterns or signs might be seen by them. You search for head and shoulders, or any other pattern for that matter, and they may or may not appear on the chart.