How To Trade The Head And Shoulders (H&S) Pattern

Head and shoulders (H&S) refers to a popular technical analysis pattern used to trade market reversals.

A classic head and shoulders indicates the probable end of an uptrend proceeded by a downtrend. Inverse head and shoulders also occur in markets, and these suggest that a downtrend should come to an end followed by an uptrend.

Structure of the pattern

When trying to spot H&S patterns on your price chart, you must look for the following: two shoulders similar in price, a higher head than both shoulders, and a neckline that connects the 1st and 2nd swing points.

You may still be slightly confused but fear not, take a look at the diagram and subsequent explanation, and everything should make sense (if not, you are probably in need of some sleep).

 

Head and shoulders diagram

Breaking it down:

Left shoulder – Price rises, forms a high and then declines.

Head – The market moves up again, this time past the peak of the left shoulder. Afterward, price falls again.

Right shoulder – Price rises for the third time to a similar level to the left shoulder and then proceeds to fall.

Neckline – Line connecting the lows of the pattern.

Structure of inverse head and shoulders

It is called the inverse H&S for a reason, just flip the pattern, and there you have it. But in case you are a bit slow today, here is another diagram and explanation.

 

Inverse head and shoulders diagram

Breaking it down:

Left shoulder – The market falls, forms a low, and then moves higher.

Head – Price declines lower than the left shoulder’s low, makes a new low, and then price rises.

Right shoulder – The market falls again to a similar price to the left shoulder, then moves up.

Neckline – Line connecting the highs of the pattern.

What does the neckline represent?

The neckline of a H&S is a form of support or resistance, meaning it shows supply and demand levels.

I must highlight that the neckline can be a trendline or a horizontal zone of support/ resistance.

 

Horizontal neckline diagram

Trading head and shoulders

Since H&S indicate a potential reversal, you must be looking to sell when seeing a conventional head and shoulders.

I would recommend using two approaches when trading H&S, both of them involve a break of the neckline.

 

Strategy one – Pure breakout

  1. Identify and plot the points of the pattern on your chart.
  2. If price breaks and closes below the neckline, open a sell position.
  3. Put your SL above the neckline.
  4. Place your TP at a similar distance to the size of the H&S pattern e.g. if the low to the high is 500 pips, then place the TP about 500 pips away.

 

H&S pure breakout trade

(Source – TradingView)

 

Strategy two – Breakout then retrace

  1. Identify and plot the points of the pattern on your chart.
  2. If price breaks below support, wait for a retracement.
  3. Once price has retraced, wait for sellers to start driving the market down again. The retracement could result in a retest of the neckline, which adds confluence.
  4. If this condition is met, open a sell position.
  5. SL above the neckline.
  6. TP at a similar distance to the size of the pattern.

 

H&S retracement trade

(Source – TradingView)

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20201016023132aff i?offer id=10&file id=540&aff id=24220

Trading the inverse head and shoulders

If you have been paying any attention to me, you will know that since inverse H&S shows a possible market bottom, you should be looking to buy.

We will use the same entry techniques as above, applied in the opposite direction.

 

Strategy one – Pure breakout

  1. Identify and plot the points of the pattern on your chart.
  2. If price breaks and closes above the neckline, open a buy position.
  3. Put your SL below the neckline.
  4. Place your TP at a similar distance as the size of the pattern.

 

Inverse H&S pure breakout trade

(Source – TradingView)

 

Strategy two – Breakout then retrace

  1. Identify and plot the points of the pattern on your chart.
  2. If price breaks above resistance, wait for a retracement.
  3. Once price has retraced, wait for buyers to start driving the market up again. The retracement could result in a retest of the neckline, which adds confluence.
  4. If this condition is met, open a buy position.
  5. SL below the neckline.
  6. TP at a similar distance to the size of the pattern.

 

Inverse H&S retracement trade

(Source – TradingView)

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aff i?offer id=10&file id=704&aff id=24220

Why does H&S work?

  • Remember, before the pattern forms, the market is trending.
  • The dominant side (bulls or bears) believes the trend should continue, so they continue entering new positions (this is what forms the left shoulder, head, and right shoulder).
  • After three attempts to push prices further in the trend direction, market participants begin unwinding their positions due to the lack of momentum.
  • Usually, this is the cause of breakouts through the neckline.
  • Once the market breaks through the neckline, the trapped traders exit their positions, leading to momentum shifting in the opposite direction.
  • At this point, the market has reversed in the opposite direction.

Conclusion

If you are interested in testing the strategies in this article, then open an account with FXCM or AvaTrade and start trading.

Don’t be too hard on yourself at first. Spotting H&S in real-time takes some time and practice, but eventually, it’s as easy as making a toasted cheese.

May the market be with you

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