Perfect step-by-step Guide to Head and Shoulders Pattern: The head and shoulder pattern is a technical analysis tool used for spotting trend reversals. This subjective and complex shape – Head & Shoulders, is formed at the top or bottom of a trend, upwards or downwards, respectively.
This short article includes an easy to read a perfect guide to head and shoulders pattern on how to forex trade this pattern in the market. It would be followed by discussing some pros and cons, and at last, we’ll understand the science behind this pattern. In other words, understand why this pattern works so well, followed by a reasonable conclusion.
Steps to Trade Head and Shoulder
- Determine the Trend: The first step in our guide to head and shoulders pattern is to identify the trend from the price chart. This pattern requires a currency to be already in a direction. Moreover, the longer the duration and sharpness of the trend, the more robust the chances of reversal.
- Confirm the pattern: The next thing is to confirm the head and shoulder pattern. A forex trader should always wait until the end of the head and then start planning his further moves. Getting into the forex market, early, can make you suffer losses.
- Plan the Prices: Once the trader confirms that the pattern is forming, and then at the end of the head, he should start planning. Price levels such as stop-loss, entry and exit points should be in the traders’ mind in advance, before reaching the trade level. Also, carefully set your benchmark and do not greed or fear here.
You can also take the help of price predicting tools such as moving average, support & resistance, and Fibonacci.
- Form a Neckline: Now, the time is to make a neckline. It is formed by connecting the points of low points of the head. Remember, only the breakage of the neckline fully confirms the pattern.
- Trade: The next step is to place the orders and set stop losses. If you want to start early, you can begin with the high point of the right Shoulder by short selling. In that case, set the stop loss at the highest point of the head.
- Watch Your Profits: Now the last step is to see your profits grow in multiples. Keep an eye on the prices daily or at least every two to three days. Also, be in touch with the news, journals, and events related to your traded currency.
So, this was a step-by-step guide to trade with head and shoulders pattern. Any forex trader, whether experienced or novice, can use it. However, please clear your primary homework first and, then try to trade.
And, knowing the pros and cons of the forex trading tool, you might use, is the first step. That’s why below are some short and sweet points on advantages and disadvantages of it. After that, we would try to understand the science behind Head & Shoulder being so successful.
Advantages of Head and Shoulder Pattern
This pattern is quite easy to spot on the price chart as compared to other technical indicators.
It is not limited to any one particular market. Be it forex, currency trading, commodity, or any other financial market, one can use it anywhere.
This pattern has outstanding potential to identify significant forex market price movements.
Unlike other tools, it takes a calculative risk and reasonable profit levels.
Disadvantages of Head and Shoulder Pattern
It can be quite complex to understand or identify to beginner players. It is usually not suitable for noise traders who do not have complete knowledge.
The price line after forming the head & shoulder pattern can also go back, and thus, confusing forex traders.
The waiting time is longer, as it requires the pattern to form fully. It can also make traders miss some excellent opportunities.
It can be confusing for a volatile asset as there would lots of ups & downs; thus, forming lots of shoulders. One peak can be the Shoulder for someone, while the same can be head for another.
Now, let’s move into understanding the science behind this tool and why it works so well!
The Science behind the Head and Shoulders Pattern
As a forex trader, you must understand, every time about the tools you use, that why they work or not. This tool is not best, but it works mostly because of the following reasons:
The first thing you need to understand is when prices fall; it means the sellers are dominating or more people are selling the currency. And, when rates rise, it means the buyers have the power.
As the market approached the highest point of the head and began falling, the sellers start to enter the market. It is because the forex market has rejected the highest price level and will fall.
However, the falling prices attract some buyers and make the price rise again but not as high as head.
But, soon, it starts to fall again, and the buyers realize that they are in losses and, in panic, they sell their asset.
This panic selling by these novice/noise traders change the overall trend and make the upward trend, a downtrend.
The last sellers among them face high losses and then exit the market. Thus, causing the forex market to fall further and approach the next low price target.
The Bottom Line
Head and Shoulder is a great tool to earn money. Many forex traders still follow the conventional method of forex trading. However, with the help of this pattern, you can also take the benefits from falling prices by short selling.
Short selling, put together, is to first sell at a higher rate without owning the asset and then buy the same asset at a lower price. You can read the full article about shorting here!
Also, no matter how reliable this tool is, the forex market is unpredictable and thus risky. It can eat up your hard-earned money quickly. The reason is other big investors are sitting there too, who earn barely from currency trading. They play with the psychology of noise traders and make money.
In all this, you can also lose. Thus, it is crucial to put stop losses and limit levels when forex trading.