Trading using the Head and Shoulders Pattern

The head and shoulders chart pattern, which appears as a baseline with three peaks, the middle peak being the highest, is a well-known and easy-to-spot pattern in technical analysis.

The head and shoulders chart displays a bullish-to-bearish trend reversal, which also suggests that an upward trend is about to end.

The pattern can be used by all traders and investors because it appears across all time periods.

The formation's entry levels, stop levels, and price goals can be easily implemented because the chart pattern offers important and easily recognizable levels.

Why the Head and Shoulders Pattern Works?

There is no perfect pattern, and it doesn't always work. The market top will be used in this justification, but the chart pattern theoretically holds true for both for a number of reasons:

Purchasing is becoming less aggressive as prices fall from the market high (head). Additionally, sellers have begun to enter the market.

As the neckline approaches, numerous investors who purchased during the right shoulder rally or the penultimate wave higher are now facing sizable losses because they made a mistake. As a result, they will now sell their positions, which will drive the price in the direction of the profit objective.

The stop above the right shoulder makes sense because it is a lower high than the head, and the right shoulder is unlikely to be broken until an uptrend resumes.

The assumption behind the profit target is that people who made mistakes or bought the security at the wrong time will be forced to sell, which will result in a reversal that is roughly equal in size to the recently formed topping pattern.

The price will move in the direction of the price objective as a result of many traders feeling pain at the neckline and being forced to close out positions.

Volume can also be seen. In inverse head and shoulders formations, we would prefer the volume to rise as a breakout occurs (market bottoms).

The increased buying activity will cause the price to approach the target more quickly. A lack of enthusiasm for the upward advance is evident from the declining volume, which warrants some skepticism.

Advantages

Experienced traders can recognize it without difficulty.

It is possible to define precisely the stop distance, entry levels, and confirmation openings and closings.

Since a head and shoulders pattern has a fairly long period, the market may experience a significant change from the entry price to the close price.

All markets, including stock and FX trading, can use the pattern.

Disadvantages

Novice traders might miss it: Without a flat neckline, the head and shoulders pattern can still manifest; this can be perplexing for new traders.

If there is a significant downhill movement over an extended period of time, large stop distances are possible.

The neckline might be retested if the price retreats, which could perplex some traders and make the neckline appear to move.