The Trading Strategy Known As "Head And Shoulders"

 The head and shoulders chart pattern is a well-known and easy-to-spot pattern that appears in technical analysis. This pattern consists of a baseline with three peaks, with the middle peak being the highest of the three peaks.

On the head and shoulders chart, we can see that there has been a trend reversal from bullish to bearish, which also indicates that an upward trend is likely going to come to an end soon.

Because the pattern is present across all time periods, it is available for use by any and all traders and investors.

Entry levels, stop levels, and price goals associated with the formation are not difficult to implement due to the fact that the chart pattern provides essential and easily recognizable levels.

What Makes the Head and Shoulders Pattern So Powerful?

There is no such thing as a perfect pattern, and following one does not guarantee success. In spite of this, the chart pattern is likely to materialize in practice for a variety of reasons (the market top will be used as an example to justify this claim; however, the pattern will materialize in either case):

As prices move closer and closer to their all-time lows, buyers are becoming less aggressive (head). Additionally, sellers have begun to participate in the market.

Many investors who bought during the penultimate wave higher or during the right shoulder rally are now facing significant losses because they were mistaken; as a result, they will now sell their positions, which will push the price in the direction of the profit objective. As the neckline gets closer, the price will continue to move in the direction of the profit objective.

Since the head is higher than the right shoulder, which is a lower high, placing the stop loss above the right shoulder makes sense. Since the trend is now moving in the opposite direction, the right shoulder is unlikely to be broken until the uptrend resumes.

The profit goal is predicated on the assumption that individuals who bought the security at an unfavorable time or made mistakes when making their purchase will be forced to sell, which will result in a reversal that is comparable in size to the topping pattern that was just recently formed.

Because of this, a significant number of market participants will start to experience discomfort at the neckline and will feel compelled to liquidate their positions. This will cause the price to move in the direction of the price objective.

Additionally, volume can be observed. In the event of an inverse head and shoulders formation, we would prefer to see an increase in volume as the breakout takes place (market bottoms).

As a result of the increased amount of buying activity, the price will move closer to the target in the near future. The decreasing volume suggests that there is a lack of enthusiasm for the upward advance, which calls for some skepticism on the part of the audience.

Advantages

Traders with experience will have no trouble recognizing it.

All aspects of the stop, including its distance, entry levels, and confirmation openings and closings, can be precisely defined.

Due to the fact that a head and shoulders pattern has a fairly extended period, a market may move significantly from the price at which it opened to the price at which it closed.

The pattern can be applied to trading in all markets, including stock and foreign exchange markets.

Disadvantages

It's possible that novice traders will miss it: The fact that the head and shoulders pattern can appear even if there isn't a flat neckline is something that can throw off inexperienced traders.

It is possible to achieve large stopping distances if there is a significant downhill movement that persists for an extended period of time.

In the event that the price makes a downward move, the neckline may be retested. While this may throw off some traders, the neckline itself may look to shift.