The head and shoulders chart pattern is a reversal pattern that is most common in uptrends.
Head and Shoulders Pattern
A trend reversal formation is a head and shoulders pattern.
It is composed of a peak (shoulder), a higher peak (head), and another lower peak (shoulder).
The lowest points of the two troughs are connected to form a “neckline.”
This line’s slope can be either up or down. When the slope is down, the signal is usually more reliable.
The head and shoulders pattern is clearly visible in this image.
The pattern’s highest point is the head, which is the second peak. The two shoulders form peaks as well, although they do not reach the height of the head.
We put an entry order below the neckline with this formation. A target can also be calculated by measuring from the highest point of the head to the neckline.
This is the approximate distance that the price will travel after breaking through the neckline.
When the price falls below the neckline, it makes a move that is at least the size of the space between the head and the neckline.
We know what you’re thinking: “the price continued to move even after it hit the target.”
“DO NOT BE GREEDY!”
Inverse Head and Shoulders
The name is self-explanatory. It’s similar to a head and shoulders formation, however this time it’s upside down.
A valley (shoulder) forms, followed by a lower valley (head), and then another higher valley (shoulder).
These formations emerge as a result of prolonged downward movements.
This pattern is similar to a head and shoulders pattern, but it is inverted upside down.
We would put a long entry order above the neckline with this configuration.
Our target is calculated in the same way as the head and shoulders pattern is.
Measure the distance between the head and the neckline to get an idea of how far the price will move when it breaks the neckline.
As you can see, the price rose nicely after it broke through the neckline.
If your goal is met, you should be pleased with your gains.
There are, however, trade management tactics that allow you to lock in some of your profits while keeping your trade open in case the price continues to move in your favor.
You will learn more about them later in the course.