What is a Head & Shoulder Pattern?
Head & Shoulder is a type of chart pattern that occurs during a reversal phase, changing the trend from an uptrend to a downtrend, and from a downtrend back to an uptrend. Traders use this reversal pattern to find entry points for their orders.
Components of the Head & Shoulders Pattern
Within the Head & Shoulder chart pattern, there are two variations: Head & Shoulder and Inverse Head & Shoulder. These consist of the Left Shoulder (abbreviated as LS), Head (abbreviated as H), Right Shoulder (abbreviated as RS), and Neckline. When the graph is already in a trend and the four components of Head & Shoulder appear, it is a signal that the graph may adjust in the future.
Formation of the Head & Shoulders Pattern
The chart begins by forming a higher high in the area of the Left Shoulder (LS), then pulls back to create a higher low. It then moves up again, making a new higher high that exceeds the previous one — this forms the Head (H). After that, the price moves down again to form a higher low at the same level as the previous higher low. The chart then climbs once more but fails to reach a new higher high, instead forming a swing high at the same level as the LS — this creates the Right Shoulder (RS). As the price drops again, we can draw the Neckline at the level where the two higher lows align. With this, all the components of the Head & Shoulders pattern in an uptrend are complete.
Formation of the Inverse Head & Shoulders Pattern
The chart begins by forming a lower low at the Left Shoulder (LS), then moves up to create a lower high. It continues downward to form a new lower low that is lower than the previous one — this becomes the Head (H). The price then moves up again to form a lower high at the same level as the previous lower high. After that, it drops again to form a swing low that is not lower than the Head but is in line with the LS — this forms the Right Shoulder (RS). When the price moves upward again, we draw the Neckline at the level where the two lower highs align. Together, these elements form a Head & Shoulders pattern in a downtrend.
How to Profit from the Head & Shoulder Pattern
There are two ways to profit from the reversal of the Head & Shoulder Pattern, which apply the same for both uptrends and downtrends. Once the chart completes all four components, focus on the area between the right shoulder (RS) and the neckline.
Trade according to the breakout.
Uptrend: When the price in the RS section touches the Neckline, traders can place a Sell order if the price breaks below the Neckline, indicating a trend change from uptrend to downtrend.
Downtrend: When the price in the RS section touches the Neckline, traders can place a Buy order. If the price breaks above the Neckline, it indicates a trend change from downtrend to uptrend.
Trade waiting for the Neckline signal
Uptrend: When the price breaks below the Neckline, we wait for the chart to rise and touch the Neckline again to confirm the trend reversal from uptrend to downtrend. Traders can then place a Sell order.
Downtrend: When the price breaks above the Neckline, we wait for the chart to drop back down to touch the Neckline again to confirm the trend reversal from downtrend to uptrend. Traders can then place a Buy order.
