How to Trade Head and Shoulder Chart Patterns


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Video Transcript:

Hello, traders. Welcome to the third module of the advanced technical analysis course: chart patterns. And in this lesson, we’re going to teach you how to trade the Head and Shoulders Pattern. Remember, the Head and Shoulders is one of the most powerful reversal patterns you can find on your charts. And, it takes a while for a Head and Shoulders to complete but when it is complete and it breaks out, you will have or you will be in a very high probability trade. So, let’s go through it. So, let’s go through it.

Head and Shoulders interest, stop losses, and targets. Let’s start with the entries of the Head and Shoulders. Of course, you must wait the break out of the neck line for you to be able to trade it. And Head and Shoulders is the most powerful reversal pattern, we already said that. And, in an uptrend after a retest of resistance price fakes out just to retest it again, creating the pattern. Remember, the fake out is when price actually breaks though the resistance area but comes back down the resistance area, okay? That is called a fake out, or a fake break out, and this is what we’re looking for. And, when we are in a Head and Shoulders, a test of resistance, then a fake out of that resistance, and a test again of the resistance, creating the second shoulder.

How to trade head and shoulders

And, the same is true in a down trend as support, and this is called an inverted Head and Shoulders. An inverted Head and Shoulders will test a support zone then fake out of the support zone. Then, we test it back to create the second shoulder of the pattern. And, here’s an example of what a Head and Shoulders looks like. As you can see here, we are in an uptrend and we tested this area of resistance just to fake out of it, a big pull back and retest of the area. Once we break with the neck line, we have a single to go short on this instrument. And, the neckline is always the trend line that joins the two lows of the pull back in a Head and Shoulders or the two highs of the pull back in an inverted Head and Shoulders.

For the stop loss levels, the stop losses should always be above the pattern’s head. And, this is simple because let’s imagine that we are here, and we are waiting for the completion of the pattern and the breakout of the neck line. And, as in this case, the breaks below… our price breaks below the neck line and we go short. And, if we pull up too tight of a stop, meaning that if we put a stop right here, right above the neck line, we might get stopped out. If when price comes down and comes back up to retest, this trend line as resistance in and then, coming going down and reaching our targets.

So, if you take too much of a tight stop loss, you take the risk to get stopped out, and, or to get stopped out on a winning trade that would have reach your target. So, and remember that stop loss levels are levels or price levels that completely invalidate your trade idea. So, if we go short here and price retests this high of, or this shoulder, we are still good on our short idea. But if we break with this high right here, it will mean that we will be making higher highs and our short idea is no longer valid. So, when we have a break out and an entry, the stop loss level should be above the patterns head. And, in a very single or an inverted Head and Shoulders, the stop loss should go below the pattern’s head.

Now, to calculate the targets of a head and shoulder, you should measure from the head or the top of the head to the neck line, from here to here. And once you have your measurement in PIPS, you should extrapolate it to the break out zone, giving you the targets of the breakout. Remember that this is also a momo setup, meaning we want to profit from the momentum of the breakout. We are not looking for a swing trade out of it. We are looking for our target. So, if you plan your trade, you should trade your plan and if you have your target set, you shouldn’t move them and you should exit your trade at those levels.

Trading Head and Shoulders with Forex

Now, let’s go through a trade analysis, okay? This is an example of a Head and Shoulders. Now, as you can see here, we are in an up move and we made this high, at some resistance area, okay? Then, we pull back to make this low and we continue to the upside, making this high. Now remember, at this stage, we don’t know if we are in a Head and Shoulders, okay, because we made a high, then we pull back, and we broke with this high, making a new higher high. Now, if we pull back, if we pull back to around this level for example, it would mean that we’re still in an uptrend and we are due to make a higher high, okay? But, when we pull back to this area, to this same area of support or the same previous area of a pull back, we start to see a head and shoulder forming, okay? We have the first shoulder then, the head and now, we have pulled back to the same pull back area to try to make the second shoulder. And in this case, we do make the second shoulder and we reject this area of resistance right here.

Now, our Head and Shoulders is complete when we have a break out of the neck line, okay? When we have a breakout of the neckline, we have a signal to go short. But, the first thing we’re going to do is we’re going to measure our targets. And, by measuring our targets I mean, we are going to grab our cross hair tool and measure from the top of the head to the neck line, and in this case, we have a 120 PIP range and we are going to extrapolate it from the possible breakout area or the neckline to get our target. OK. And this, in this case, this Head and Shoulders can yield 120 PIPS. It’s something to look for because to get a clean 120 PIP moves is very rare but if you are patient enough, you will be able to get them with some Head and Shoulders and these patterns breakout.

Now, when we the break out, we have the signal to go short. And in this case, we can put our stops above the pattern head giving us a one to one risk to reward in this trade. Now, all you need to do is be patient. And, when you start seeing things just like we saw here, I mean, a test of a resistance, then a pull back, then a higher high, and when you get a complete pull back to the same first pull back area, you can start looking at the chart more closely because you might be in a Head and Shoulders, or the price may be creating a Head and Shoulders meaning that we can, we might be getting a great risk to reward and a great trade with a high probability rate.

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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