Head-and-shoulders strategy

The head and shoulders chart pattern displays a baseline with three peaks, the middle peak being the highest.

The head and shoulders chart shows a bullish-to-bearish trend reversal, indicating an upward trend is ending.

The pattern is present on all time periods, so traders and investors can use it.

Entry levels, stop levels, and price goals are easy to implement due to the chart pattern's clear levels.

Why Does Head-Shoulders Work?

No pattern is perfect or reliable. The chart pattern holds true for a number of reasons (the market top will be used, but it holds true for both):

As prices fall from their high, buyers are less aggressive (head). Sellers have also arrived.

As the neckline approaches, many investors who bought during the penultimate wave higher or the right shoulder rally are facing significant losses and will sell their positions, pushing the price toward the profit objective.

The right shoulder is lower than the head, so the stop above it makes sense because the trend has switched downward and the right shoulder won't be broken until an uptrend returns.

The profit goal is based on the idea that people who made mistakes or bought the security at a bad time will be forced to sell, causing a reversal comparable to the recently formed topping pattern.

Many traders will feel pain at the neckline and close positions, driving the price toward the price objective.

Observe volume. We prefer volume to rise during inverse head-and-shoulders breakouts (market bottoms).

Due to increased buying, the price will approach the goal. Declining volume indicates lack of enthusiasm for the upswing and calls for skepticism.

Advantages

Traders can spot it.

Stop distance, entry levels, and confirmation openings and closings are all measurable.

A head and shoulders pattern has a long period, so the market may move dramatically from entry to close.

Pattern applies to stock and FX trading.

Disadvantages

Beginners may miss it: Head and shoulders can appear without a flat neckline, confusing novice traders.

Long downhill movements allow for large stop distances.

If the price pulls back, the neckline may be retested, confusing some traders.

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