Among the predictive patterns of technical analysis, the head and shoulders is one of the most accurate.
It reflects three surges in the price of a currency of different heights, after which the trend reverses. However, its value lies not only in the fact that it reflects the patterns of the struggle between bullish and bearish trends.
More importantly, it gives traders a hint about the most efficient entry points to the market and also indicates how far the price of the currency will fall or rise after the trend reverses.
What Is the Head and Shoulders Pattern?
Fluctuations in the price of a currency, represented on the charts, can create stable patterns. The head and shoulders pattern Forex is so named because it consists of three peaks, the middle of which rises above the other two like a head over the shoulders. In total, there are three ups and three downs in the currency price in this chart pattern:
- Left shoulder: first bullish trend reaches the peak, followed by a reversal and first trough.
- Head: The second bullish trend rises well above the left shoulder but also proves to be unsustainable and gives way to a bearish trend.
- Right shoulder: this is the last attempt to raise the price of the asset, which is exhausted before reaching the level of the head and is finally replaced by a bearish trend.
In addition to these three figures of the pattern, traders distinguish the neckline. It connects the lowest points of this figure to which the price falls. Visually, it can be horizontal or tilted up or down. When tilted down, the signal is considered more reliable, as there may be a false head and shoulders pattern.
Understanding the different types of Head and Shoulder patterns is an important aspect of technical analysis for traders in the Forex market. However, it is important for traders to choose the right Forex broker to ensure successful trading patterns and strategies. In order to make informed decisions, traders must do deep research and find important tips, trends, and platforms. For example, by reading the reviews of top FX brokers such as to look up the review of IG FX brokers or other most popular ones, as a trader you may gain more insight into your experience in creating a successful trading strategy.
Types of Head and Shoulders Patterns
What is the head and shoulders pattern in terms of the nature of the trend reversal? The versatility of this chart pattern is that it indicates both a change from a bullish trend to a bearish one and vice versa. The signal depends on whether this pattern is up or down:
- A straight head and shoulders pattern indicates that after three attempts by the asset price to reach a new stable level, there is a pullback and the price of the currency falls.
- An inverse pattern indicates exactly the opposite trend: three price lows with the largest in the middle are replaced by a bullish trend.
Thus, the inverted pattern is a mirror image of the straight pattern and looks like three troughs of different sizes.
Trading Strategies for the Head and Shoulders Pattern
Since there is a false head and shoulders pattern, there is no need to rush to place an order before it has fully formed. If this pattern is complete, we can expect the price of the asset to fall by about an amount from the top of the head to the neck. If it has not yet formed, then the price of the currency may rise again contrary to expectations. Therefore, only when the price breaks the neckline, you can start placing orders:
- A short position is opened with a straight head and shoulders pattern.
- A long position is opened with an inverse pattern.
The Forex head and shoulders trading pattern also signals when to exit a position. It is most reasonable to do this approximately at a level mirroring the distance from the top of the head to the neckline. However, if you are ready to take risks and there have not yet been other signals about an imminent trend reversal, you can stay in this position for a longer time.
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The head and shoulders pattern is a classic in trading because it has proven itself to be an extremely effective predictive tool. It shows the trend reversal, as well as the approximate level to which the price of the currency will fall or rise. However, orders should be placed only after the pattern has fully formed. In order not to make mistakes in interpreting signals, use Forex EA, the exact algorithms of which protect you from false signals.