Head and Shoulders

A head and shoulders pattern is also an indication of a trend reversal formation.

It is formed by a peak (shoulder), followed by a higher peak (head), and then a further lower peak (shoulder). A neckline is drawn by connecting the lowest points of the two troughs. The slope of this line can either be up or down and sometimes can be a little tricky to spot.

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The head is the second peak and is the highest point in the pattern. The two shoulders also form peaks but do not exceed the height of the head.

With this formation, we put an entry order below the neckline.

We can also calculate a target by measuring the high point of the head to the neckline. This distance is approximately how far the price will move after it breaks the neckline.

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You can see that once the price goes below the neckline it makes a move that is at least the size of the distance between the head and the neckline.

Inverse Head and Shoulders

The name speaks for itself. It is basically a head and shoulders formation, except this time it’s upside down.

A valley is formed (shoulder), followed by an even lower valley (head), and then another higher valley (shoulder). These formations occur after extended downward movements.

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In bear market trends the head and shoulders is inverted. With this formation, we would place a long entry order above the neckline.

A targets can be calculated just in exactly the same way. Measure the distance between the head and the neckline, and that is approximately the distance that the price will move after it breaks the neck.

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If your target is hit, exit the position, don’t forget to use a stop loss. However, there are trade management techniques where you can lock in some of your profits and still keep your trade open in case the price continues to move your way, for example “trailing stops”.