Head and Shoulders
The head and shoulders is a trend reversal pattern. It marks a will to make a bearish reversal. The principle is the same like a triple top except that the second top is higher than the others (which are theoretically at the same height). So, the head and shoulders pattern is formed by three tops that will succeed.
The first and third tops are approximately at the same height. We say that they formed the shoulders. The second top is higher than the other and represents the highest point. This is the head. There are no rules for some investors say that the height of the head must be 1.5 or 2 times higher than shoulders. Investors also agreed to say that spacing between each top must be the same. This is a key point to identify the pattern.
The lowest reached between each shoulder and the head shape the neck line (below in red) that act as support. The neckline may be ascending (52% of cases), descending (43% of cases) or horizontal (10% of cases). This is the breakout of this support that validates the reversal pattern. The target price is equal to the distance between the neckline and the top of the head that we symmetrically carry over the neck line. This pattern is often well known to investors and that is what made it success.
Here is a graphical representation of a symmetrical broadening bottom:
Here are some statistics about the head and shoulders:
- In 93% of cases, there is a downward exit
- In 96% of cases, there is a pursuit of the bearish movement at the breakout of the neckline
- In 63% of cases, the target of the pattern is reached once the neckline broken
- In 45% of cases, a pullback occur on the neckline
- More the trend before the formation of the head and shoulders is long, more the downward movement at the breakout of the neck line will be strong.
- More the movement preceding the formation of the head and shoulders is brutal, more the downward movement at the breakout of the neckline will be important
- Patterns with an ascending neckline gives better performance
- If the left shoulder is over the right shoulder, the pattern gives better performance
- Pullbacks on the neckline are harmful to the performance of the pattern.
The classic strategy:
Entry: Take a short position at the breakout of the neckline
Stop: The stop is placed above the neckline
Target: Theoretical target of the pattern
Advantage: The pattern is offering a good performance at the breakout of the neckline
Disadvantage: At the breakout of the neckline, an important part of the movement has been lost.
The aggressive strategy:
Entry: Take a short position when the pattern is confirmed (after the second shoulder)
Stop: The stop is placed above the last shoulders
Target: Return on the neckline and Theoretical target of the pattern
Advantage: In 93% of cases, the exit is downward when the pattern is confirmed
Others Chart Patterns :
Chart patterns are at the basis of technical analysis. They are distinguished into three categories: Reversal Patterns – Continuation Patterns – Neutral Patterns. Chart patterns are formed on the charts of historical data of different pairs. They appear on all timeframes.