The Head & Shoulders (H&S) pattern is a popular and widely recognized chart pattern used in technical analysis to identify potential trend reversals. It typically signals the end of an uptrend and the beginning of a new downtrend. The pattern consists of three peaks, with the middle peak (the "Head") being higher than the other two peaks (the "Shoulders").
(Fig 1.1 - Head & Shoulder)
Here's how the H&S pattern forms and what it signifies:
Left Shoulder: The pattern begins with an uptrend, represented by a peak (shoulder) followed by a pullback and a subsequent rally to a higher peak (the head).
Head: After the first peak, the price retraces before rallying to form a higher peak, known as the head of the pattern. The head is usually the highest point in the pattern.
Right Shoulder: Following the head, there's another pullback in price, followed by a final rally attempt that fails to surpass the high of the head. This creates a third peak, which is lower than the head and often similar in height to the left shoulder.
Neckline: The neckline is a trendline drawn through the lows of the pullbacks between the peaks. It serves as a support level for the price. Once the price breaks below the neckline, it confirms the completion of the pattern and signals a potential trend reversal.
The H&S pattern is considered complete when the price breaks below the neckline after forming the right shoulder. Traders often use this breakout as a signal to initiate short positions or to exit long positions, anticipating further downward movement in price.
It's important to note that while the Head and Shoulders pattern is widely recognized, it's not always perfectly symmetrical, and variations in its structure can occur.
Additionally, like any technical analysis tool, false signals can occur, called as pattern failure. A pattern failure on the H&S can occur in many ways like the price after breaking below the neckline reverses and closes above the right shoulder. Or a small bullish pattern forms right after the breach of the neckline and a subsequent bullish breakout happens.
A pattern failure can be very strong as it traps the bears who may be forced to exit their bearish bets as the price starts moving in the opposite direction. We will share examples when we discuss our setups to show how this happens and how to capitalize on it. In fact, our Trading System is geared to take advantage of pattern failures.
Reverse Head & Shoulder is a bullish pattern, the exact reverse of H&S above. Please refer to the image below.
(Fig 1.2 - Reverse Head & Shoulder)
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