Head and Shoulders Pattern

With a Head and Shoulders pattern in the media on several occasions lately, I thought I would add a page of my own on the subject.
Everyone seems to have there own opinion on the outcome of this particular pattern and I guess I have my own as well.
Being a self taught trader, I take in as much knowledge as I can over periods of time, I interpret this knowledge which many times is varied from source to source, and then I come up with my own conclusions.
As time goes by, if I see my conclusions are incorrect, I adjust them to try and become more accurate with the goal of obtaining a higher probability of successful results.
Enough of how I come to my conclusions, let's move on to some of the characteristics of this particular chart pattern:

A Head and Shoulders Pattern is generally considered a "Reversal Pattern", meaning whatever the trend was prior to the pattern itself, the trend after the pattern will reverse.
The pattern can form at the top as well as at a bottom, in which case it is called a Head and Shoulders Bottom, or Inverted Head and Shoulders.
A neckline can be drawn from both points of the neck at the base of the head and does not have to be perfectly horizontal.
Volume plays a considerable role in recognizing this pattern.
This pattern, like any other pattern, does not work 100% of the time. That is why there are "Fakeouts" and "Reversal" from within the pattern itself on occasion.

The first example below is showing a Head and Shoulders Top:

Notice the neckline I have drawn in Red and how I extended it for possible future support/resistance levels. You can also see that the trend prior to the pattern itself was up, then the pattern formed, and then a reversal which is now the downtrend shown.
Volume on the rise into the head should be lighter than the left shoulder indicating buying is weakening, and the volume on the rise into the right shoulder is usually even lighter than the head, leading to a final move lower from an increased number of sellers.
The next example is showing an Inverted Head and Shoulders bottom:

Notice that this is still a reversal pattern. The trend prior to the pattern was down, then the pattern formed, and then a reversal in the trend begins into an uptrend.
You can see the neckline again is drawn in red. Volume down into the head many times is lighter than down into the left shoulder, and volume up out of the head is heavier than the rise out of the left shoulder, showing that an increasing number of buyers are stepping in. Volume down into the right shoulder is lighter than the left shoulder as well.

Remember that a Head and Shoulders pattern is primarily a Reversal pattern. This means that whatever the trend was prior to the pattern will most likely reverse after the pattern is complete. If it does not, it is probable that the pattern was not a Head and Shoulders pattern to begin with, only similar.
Also keep in mind that the more people expecting a pattern to complete and take its expected path, the less likely it will happen. This occurred recently with the S&P and DOW in July 2009. The media was all over announcing the pattern as it was forming. What happened? Prices reversed and inexperienced traders who thought patterns always work were faked out and lost money.
Here are more pages to help with various chart patterns:

Pattern Recognition

Chart Patterns - Double Tops & Double Bottoms

Double Tops & Double Bottoms Double Tops provide technical traders with an indication of a beginning downward trend. Double Tops occur when a new high is plotted, raising the resistance level. The price then retraces and declines, only to rise again and reach the same high or resistance level.

The psychology behind a double top is thought to work like this:

Traders around the globe push the price to a new high; because the new high is a tad extreme the price retraces.
Again traders push up to the same level, testing it just one more time; again the price feels too extreme.
The market has decided that an upwards trend is just not in the cards, twice a new high was tested and twice the market sold to push it back down.

After observing a Double Top, many traders assume that for the time being the market will move in a downwards trend, thus affording an opportunity to sell, or exit a soon to be falling long position.

Double Bottoms are just the opposite of Double Tops. Twice the market will test a new low, and twice the market will refuse the idea of pushing beyond that point. The buyers will rally and an uptrend will follow.

Pattern Recognition Systems can automatically identify and alert Forex traders of double tops and double bottoms patterns.

Chart Pattern - Triangles

There are three types of triangles that technical traders focus on:

Ascending Triangle
Descending Triangle
Symmetrical Triangle

Ascending Triangles

Ascending triangles are considered bullish Forex chart pattern formations, though depending on whether they are formed during an up-trend or a down-trend they may have different implications regarding future price movement. Spotted within an up-trend an ascending triangle is typically considered an indication that the upwards trend will continue. Just the opposite, if an ascending triangle forms during a downwards trend it is considered an indication of a trend reversal. Essentially, ascending triangles are comprised of a series of candles that form the shape of a triangle. The term ascending triangle refers to the fact that the triangle's two trend lines are not created equally; the top line of the triangle will represent a fairly even level of high prices, while the lower level of the triangle will represent a continued series of higher lows.

The consolidation between buyers and sellers at an upward slant suggests pressure from the buyers. The resistance line can typically only hold for so long before the buyers get the best of the sellers and the price breaks out in an upwards trend, at which point the resistance level often becomes the new support level. Figure 3 shows an example of an ascending triangle chart pattern.

Descending Triangles

Descending triangles are just the opposite of ascending triangles. In a downwards trend the triangle forms as an indication that the trend will continue downwards. In an upwards trend the triangle forms as an indication of a trend reversal. Descending triangles are formed when there is a series of progressively lower highs and relatively even lows. As can be seen in the image below the top line or resistance line of the triangle will be angled down, while the lower line or support level will appear as a level horizontal line.

Symmetrical Triangles

Symmetrical triangles are most often considered a continuation chart pattern. Symmetrical triangles can be seen as a series of lower highs and higher lows develop forming the shape of a triangle. This pattern represents a struggle between buyers and sellers, as is usually the case with price consolidation; more often than not symmetrical triangles precede a price breakout. Though it is generally safe to assume that symmetrical triangles will only present themselves as an indication that the current trend either upwards or downwards will continue, this may not always be the case.

Triangle patterns can automatically be identified by Pattern Recognition Systems and alert Forex traders as they emerge.

Chart Pattern - Wedges

Wedges are often considered a difficult Forex chart pattern to recognize, and or are often confused with triangles. The key to spotting the difference is found in the slant or the angle of the support or resistance line. When observing triangles notice that ascending triangles show a flat or even resistance line, conversely descending triangles show a flat or even support line. Symmetrical triangles, as their name suggests, are neither slanted downwards or upwards. Wedges on the other hand, are represented by support and resistance lines that both slant in the same direction, be it up or down.

There are two types of wedges: rising wedges and falling wedges.

Falling Wedges

Falling wedges are considered bullish Forex chart pattern formations. When found in a downwards trend the falling wedge suggests a reversal of the trend. When found in an upwards trend the falling wedge suggests a continuation of the upwards trend. The falling wedge is formed by a series of lower highs and lower lows. Notice that both the support and resistance levels of the wedge are slanted downwards, this is what sets this pattern apart from a triangle chart pattern. Prices within the falling wedge will continue to tighten until the resistance line is finally penetrated and the breakout upwards begins.

Rising Wedges

Rising wedges, the opposite of falling wedges, are considered bearish patterns and are represented by a series of continued higher highs and higher lows which are narrowing or consolidating. The rising wedge suggests that though the buyers are reaching new highs, these highs a progressively tighter and tighter. These progressively tighter highs indicate that the upwards trend is losing steam. A rising wedge found in an upwards trend would suggest a trend reversal and a rising wedge found in a downwards trend would suggest a short rally from the buyers, but ultimately a continuation of the downwards trend.

Pattern Recognition Systems can correctly identify and alert Forex traders of wedge patterns.

Chart Pattern - Flags & Pennants

Flags and pennants are perhaps the most common of continuation chart patterns. Spotting a flag or a pennant usually begins with noticing the flag pole, or the trend line. Flags and pennants typically form after a substantial trend up or down as an indication that the price is consolidating or being tested before continuing in the initial direction of the trend. Often the consolidation period (the flag or pennant) is slanted in a direction opposite of the initial trend, this demonstrates the Forex market's hesitation to continue upwards or downwards, but ultimately it is nothing more than a hesitation and an indication that the initial trend is continuing.

Though both flags and pennants indicate a continuation of the current trend, there is a distinct visual difference between the two. The flag is usually represented by a more rectangular consolidation period, ( view figure 7 ) meaning both support and resistance levels will be about an equal distance from one another. A pennant on the other hand will be represented by support and resistance levels that are moving towards one another in the shape of an asymmetrical triangle. Both the flag and the pennant are always spotted at the end of the flag pole, or at the end of a sharp directional trend.

A good Pattern Recognition System can automatically identify and alert Forex traders of flag and pennant patterns.

Chart Pattern - Head & Shoulders / Reverse Head & Shoulders

Head and shoulders are usually found after a long trend either up or down. . Consisting of three peaks, one of which (the head) is centered and higher than the two lower and relatively equal peaks (the shoulders). Head and Shoulders is perhaps the most well known reversal patterns. Formed after a long upwards trend the left shoulder begins to form while still in the upwards trend. Essentially the left shoulder forms as prices rally up and quickly thereafter retrace, typically the upwards trend line, or resistance level will not be broken as this happens. Notice that when the left shoulder is seen alone, it can also be viewed as a forming flag. As the left shoulder completes, prices again rally, this time to a new high which will become the head of the chart pattern. After the high peak or head of the pattern is formed and prices have retraced back down, again prices will rally to near the same level as the left shoulder to form the right shoulder.

Essentially, within an upwards trend prices have attempted to rally three times and each rally has seen limited success, or in other words has been rejected by the sellers. Once the right shoulder breaks through the support line equal with the right shoulder (the neck line), the reversal of the trend has officially begun. Buyers have tried to continue the upwards trend, and three times have lost their battle to the sellers.

Reverse Head and Shoulders

Reverse head and shoulders represent essentially the same situation as normal head and shoulders, but of course are found in long term downwards trends as opposed to long term upwards trends. Instead of the head and shoulders represented by new peak highs they are represented by new peak lows. The reverse head and shoulders tips the trader that the downwards trend is losing steam as three new lows have been tested and each time bested by the buyers in the market.

Use our Pattern Recognition System from our Forex trading tools section to automatically detect and alert you to emerging head & shoulder patterns.

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