Head and Shoulders
The chart pattern “head and shoulders” belongs to the group of bearish reversal chart patterns. It is extremely popular among currency traders. It’s important for traders to master this pattern on a demo trading platform as it can be used for picking pips from the Forex market. The head and shoulders graphical price pattern signals the end of trend and the following change in direction of the asset’s price. It is typically formed in a developed uptrend.
Head and Shoulders Formation
As the name implies, this pattern resembles a head leant on both sides by shoulders. Its formation is based on three peaks and two troughs:
- First peak which is followed by a trough;
- Second peak that is higher than the first peak and is followed by another trough at almost equal level as the first one;
- Third peak that is not as high as the second peak and may or may not be at the same level as the first peak.
Head and Shoulders Interpretation
The first peak i.e. the left shoulder occurs as the price of the currency pair in a rising market hits a high and then fall back to the neckline. The second peak, i.e. the head occurs when prices rise to an even higher high and then fall back again to the neckline. The third peak i.e. the right shoulder occurs when prices rise again but don't hit the high of the head. The neckline becomes a key support level once the pattern is completed. And the pattern is complete when support provided by the neckline is "broken." Once the pattern is formed and the price falls below the neckline or support level (plus possible deviation), investors get a sell signal. The expectation is that the decline will continue, although prices may rebound to the neckline, considered now a resistance, but generally stop around it. According to currency analysts the head and shoulders pattern is not confirmed until the currency price closes below the support neckline. This means that it is not enough to trade below the support neckline.
The price depending on head and shoulders pattern formation is generally believed to drop at least to its target level which is calculated in the following way:
T = N – (H – N),
T – target level;
N – neckline level (initial support);
H – pattern’s head level (highest top).