The Head and Shoulders pattern is one of the commonly referenced price patterns in forex trading due to its ability to indicate trend reversals. This pattern can be found on various time frames, making it relevant for use in both short-term and long-term trading strategies.
Formation of the Head and Shoulders Pattern
The Head and Shoulders pattern occurs in an uptrend and signals a potential reversal of the trend. It is easily recognizable by the presence of a head followed by two shoulders on either side. This pattern formation can be identified on all time frames, allowing for its use in various types of trading.
To recognize this pattern, traders need to understand that prices tend to form waves similar to Elliot wave patterns, where strong trends are typically followed by corrections. Trend reversals usually occur when prices fail to break through the neckline. The lower the neckline tends, the higher the probability of a trend reversal.
Trading Steps with the Head and Shoulders Pattern
- Identify the Head and Shoulders pattern by observing the head, left shoulder, and right shoulder.
- Draw the neckline by connecting the support points on the left shoulder and right shoulder.
- Sell entries can be made after prices break through the neckline as support, with a stop loss placed above the right shoulder (sell-1).
- Sell entries can also be made if prices fail to break through the neckline as resistance, with a stop loss placed a few pips above the neckline (sell-2).
Determining Take Profit Levels (TP)
Take profit levels can be determined by measuring the distance between the head and the neckline. The probability of success is quite high, especially if the neckline tends downwards. However, traders can also use other take profit references according to their preferences and market conditions.
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