We use a range of cookies to give you the best possible browsing experience. By continuing to use this website, you agree to our use of cookies.
You can learn more about our cookie policy here, or by following the link at the bottom of any page on our site.

Free Trading Guides
EUR/USD
Bearish
Low
High
of clients are net long.
of clients are net short.
Long Short

Note: Low and High figures are for the trading day.

Data provided by
GBP/USD
Bearish
Low
High
of clients are net long.
of clients are net short.
Long Short

Note: Low and High figures are for the trading day.

Data provided by
USD/JPY
Mixed
Gold
Mixed
Oil - US Crude
Mixed
Bitcoin
Mixed
More View more
Notice

DailyFX PLUS Content Now Available Freely to all DailyFX Users

Real Time News
  • The #Euro is struggling for direction against the US Dollar but the near-term downtrend guiding it lower since late June remains firmly intact. Where is $EURUSD heading? Get your technical analysis from @IlyaSpivak here: https://t.co/us6AINmuoe https://t.co/J4hQtyprYf
  • $DXY & $SPX500 hold steady after #FED rate cut. Get your update from @JohnKicklighter here: https://t.co/vqXlKCMDYA
  • Dow Jones & Dax 30 levels to watch ahead of the fed from @PeterHanksFX here: https://t.co/iUIrsygKz2
  • The politics of the US and UK may be starkly divided but their grip on the vast, $6.6 trillion global foreign exchange trade seems as tight as ever. Get your market update from @DavidCottleFX here:https://t.co/xTKHOvrIqg https://t.co/vtHhdnF82Q
  • How can confidence in trading help with avoiding #FOMOintrading? Find out from @WVenketas here: https://t.co/MY7j9ISn4S https://t.co/n7XwfiDZz2
  • The week saw a slightly more dovish than expected RBA minutes increase the importance of the latest labour market report, which showed an uptick in the unemployment rate to 5.3%. Where is $AUDUSD heading? Find out from @JMcQueenFX here: https://t.co/odj2lLRrGf https://t.co/gmGjlGBvjv
  • #OOTT https://t.co/TLgP7dUqFv
  • #Silver’s recent bull run may have run its course in the short-term with the sharp sell-off from the September 4 high print at $19.66/oz.Where is Silver heading? Get your market update from @nickcawley1 here: https://t.co/oVAZ4wPR7z https://t.co/1LvLXmqnwx
  • RT @Frances_Coppola: NY Fed thinks reserve hoarding by a small number of banks caused the repo tantrum. Question is, why are they hoarding…
  • Gold Prices Weekly Technical Forecast, Finding Upside Commitment? #GoldPrice #XAUUSD #Gold - https://www.dailyfx.com/forex/technical/article/fx_technical_weekly/2019/09/20/Gold-Prices-Weekly-Technical-Forecast-Finding-Upside-Commitment.html?utm_source=Twitter&utm_medium=Dubrovsky&utm_campaign=twr https://t.co/CgaaEzb2li
The Head and Shoulders Pattern: A Trader’s Guide

The Head and Shoulders Pattern: A Trader’s Guide

2019-06-25 12:49:00
Warren Venketas, Markets Writer
Share:

Often considered the most steadfast of all major reversal patterns, the Head and Shoulders chart pattern is employed by novice and experience traders alike to speculate on both forex and stock markets. The benefit of this chart pattern is defined areas to set risk levels and profit targets.

The inverse (reverse) head an shoulders pattern is equally useful in any trader’s arsenal and adopts the same approach as the traditional formation. The head and shoulders stock and forex analysis process will exercise the same logic, which will be explored in this article .

Head and Shoulders Chart Pattern: Main Talking Points

  • What is a Head and Shoulders pattern?
  • What is the Inverse Head and Shoulders pattern?
  • How to identify Head and Shoulders patterns on forex and stock charts
  • Advantages and limitations of the Head and Shoulders pattern

Try out our interactive trading quiz on forex patterns!

What is the Head and Shoulders Pattern?

The Head and Shoulders chart pattern is a price reversal pattern that helps traders identify when a reversal may be underway after a trend has exhausted itself. This reversal signals the end of an uptrend. The Head and Shoulders pattern has a distinctive appearance resembling its namesake which includes a distinct ‘left shoulder’, ‘head’, ‘right shoulder’ and ‘neckline’ formation (see image below).

head and shoulders chart pattern

What is the Inverse Head and Shoulders Pattern?

The Inverse Head and Shoulders (informally known as the 'Reverse Head and Shoulders pattern) resembles the same structure as the standard foration but reversed. The Inverse Head and Shoulders is observable in a downtrend (see image below) and indicates a reversal of a downtrend as higher lows are created.

inverse head and shoulders chart pattern

How to identify Head and Shoulders Patterns on Forex & Stock Charts

Recognizing the Head and Shoulders pattern on both forex and stock charts entail the exact same actions; making it a versatile tool to include in any trading strategy. The following list gives a simple breakdown of the key action points when identifying this pattern:

  1. Identify the overall market trend using price action and technical indicators (preceding uptrend)
  2. Isolate the Head and Shoulders chart construction
  3. The distance between the ‘Head’ and ‘Shoulders’ should be as close to equidistant as possible
  4. Delineate the neckline at the low point between both ‘shoulders’ – preferably horizontal but not obligatory

These steps are applicable to identifying both the standard and reverse head and shoulders patterns.

How to Trade the Head and Shoulders Pattern

Once a trader knows how to identify the standard and inverse head and shoulders patterns, it’s relatively easy to apply it to technical analysis in both forex and equity markets.

Trading stocks with the Head and Shoulders pattern

trading the head and shoulders pattern

The chart above shows a Head and Shoulders pattern on the Germany 30 (DAX 30) stock index. The formation of the pattern is clear with the neckline highlighted by the dashed blue horizontal line. Traders will look to enter a short trade after a confirmation close below the neckline as seen by the ‘ENTRY’ label on the chart or the pip movement below the neckline. Some traders employ the ‘two-day’ close rule which necessitates a second confirmation candle closing below the neckline before opening the short trade. Trading on the pip break below the neckline allows traders to benefit from the full move down however, this tactic is riskier in that the breakout below the neckline has not been confirmed by a candle close.

There is a general rule of thumb to designate stop and limit levels. Taking the high point off the ‘right shoulder’ will specify the stop level whilst the vertical distance between the neckline and high of the ‘head’ will approximate the limit distance – 1832.8 pips in this case. The risk-reward ratio on this trade is roughly 1:1.2 which is still within the DailyFX recommended risk management parameters.

Trading forex with the Inverse Head and Shoulders pattern

trading the inverse head and shoulders pattern

The Inverse Head and Shoulder pattern on the USD/ZAR forex pair above shows an asymmetrical structure which is quite common in most formations. The neckline is slightly skewed, however still maintaining the integrity of the pattern.

The long entry level is highlighted by the neckline break or the price candle close above the neckline. The stop distance is taken from the low from the ‘right shoulder’ whilst the limit distance is calculated by measuring the distance from the ‘head’ low to the neckline.

Advantages and Limitations of the Head and Shoulders Pattern

Advantages

Limitations

Easy to identify for more experienced traders

Difficult to identify for novice traders

Defined risk and take profit levels

Confirmation candle may close far below neckline resulting in large stop loss distances which may need to be reviewed

Potential to exploit big market movements

Price can pullback and retest the neckline often confusing beginner traders

Useful in all markets

Risk-reward ratios are not always favourable

Further Reading on Forex Trading Patterns

  • Reading a candlestick chart is an important foundation to have before analyzing more complex techniques.
  • Doji candlesticks are another common pattern all traders should be able to identify in order to apply effective technical analysis to their trades.
  • Technical traders have different styles and forex trading strategies. Explore these thoroughly to find out if this type of analysis suits your personality.
  • If you are just starting out on your trading journey it is essential to understand the basics of forex trading in our New to Forex guide.
  • Don't forget to take our quiz to see how well you can identify common forex trading patterns.

provides forex news and technical analysis on the trends that influence the global currency markets.

DISCLOSURES

News & Analysis at your fingertips.