How to Trade using the Head and Shoulders Pattern?

In technical analysis, a head and shoulders pattern is widely used. A specific chart formation indicates a trend reversal from bullish to bearish. The pattern appears as a baseline with three peaks, the outside two of which are close in height and the middle of which is the highest. 

The head and shoulders pattern is one of the most reliable chart patterns and is considered a strong signal of a forthcoming reversal. There are two main head and shoulder patterns: inverted and regular. The inverted pattern is a bearish reversal signal, and the regular pattern is a bullish reversal signal. 

The head and shoulders pattern emerges when the price action creates a peak (the head), followed by a higher peak (the right shoulder), and then a lower peak (the left shoulder). The pattern is completed when the price action falls below the neckline. The neckline is created by drawing a line connecting the low of the head and the left shoulder. 

The head and shoulders pattern is a bearish reversal signal when it forms in an uptrend and a bullish reversal signal in a downtrend. 

The main difference between the two types of head and shoulders patterns is that the inverted pattern has a higher low between the head and the left shoulder, while the regular pattern has a lower low between the head and left shoulder. 

 

How to utilize the pattern 

When used in trading, the head and shoulders pattern is reliable for predicting a market trend reversal. However, newbie traders must be familiar with the basics of technical analysis and chart patterns before attempting to trade with this pattern. 

The first step is identifying the chart's head and shoulders pattern. This can be done by looking for a baseline, or support line, with three peaks. The middle peak should be the highest, and the two outside peaks should be close in height. 

Once the head and shoulders pattern has been identified, traders must wait for the neckline, or resistance line, to be broken. This signals that the trend has reversed from bullish to bearish. 

At this point, traders can open a short position or sell their assets. Stop Loss orders should be placed below the neckline to protect against false breaks. 

Take Profit orders can be placed at previous support levels or a Fibonacci retracement level. A Fibonacci retracement is tool traders use to find likely support or resistance levels based on Fibonacci ratios. 

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