Head and Shoulders Pattern
Today I want to discuss the Head and Shoulders trading pattern. I will be going in detail tomorrow in our Day Trading Room U.S. session class to explain why I sent this Forex Trading Signal on Friday. Let’s start by talking about the pattern and why I like it. The head and shoulders pattern is a reversal pattern and it is seen in uptrends. The winning percent becomes more favorable when this pattern is found in an uptrend rather than a downtrend.
Basically, the market begins to get slower and buyers dry up. Sellers come in at the highs (left shoulder) and the downside is probed (neckline.) Buyers soon return to the market and ultimately push through to new highs (head.) The new highs are quickly turned back and the downside is tested again (neckline.) Buying then comes about once again and the market rallies once more, but fails to take out the previous high. This becomes the right shoulder. Once again buying gets weaker and the market downside is tested once again. One thing to keep in mind is that in Forex we do not have volume that you can rely on since there is no central exchange. In stocks measure the volume on this pattern as volume should increase on the break of the neckline. What I normally do is start my shorts before the break, then if it does not break after a certain period of time I will simply exit my trade. Another method is to wait for the break and then set your stop above the right shoulder.
Head and Shoulders Pattern Examples:
Notice below my four hour chart head and shoulders pattern. It is important to note that this pattern does not become ‘official’ until is breaks the neckline. THE NECKLINE IS 1.7200, IF WE DO NOT BREAK THIS BY LATE U.S. SESSION I WILL EXIT.
UPDATE: We ended up with +30 pips on this trade as we exited at 1.7209, since we did not break the 1.7200 neckline. This is a good example that not every head and shoulders will work out. So the important element to remember is WAIT till the neckline breaks to take add. I took shorts before the neckline broker, however I was prepared to exit if we did not break.
Here is another example of a Head and Shoulders Pattern. I am adding this in on 8-26-2013, since we took this trade in U.S. session today.
This AUD/JPY ended up working great for +33 pips, even more if the trader decided to hold. The end result was a drop of over +130 pips in the next 24 hours to follow.
Here is a video I made to explain the head and shoulders pattern a bit more clear. Notice that this pattern can have various exits depending upon your style of day trading.