Head And Shoulders Investing Strategy

The head and shoulders chart pattern is a well-known and easy-to-identify pattern in technical analysis that consists of a baseline with three peaks, with the middle peak being the highest.

On the head and shoulders chart, a bullish-to-bearish trend reversal is depicted, indicating that an upward trend is about to end.

The pattern can be utilized by all traders and investors because it exists across all time periods.

The formation's entry levels, stop levels, and price objectives are easy to implement due to the chart pattern's provision of critical and easily discernible levels.

Why Does the Head and Shoulders Pattern Work?

There is no perfect pattern, and it does not always work. Nevertheless, the chart pattern theoretically holds true for a variety of reasons (the market top will be used as an example, but it holds true for both):

As prices fall from the market's peak, less aggressive buying is occurring (head). Additionally, sellers have begun to enter the market.

As the neckline approaches, many investors who bought during the penultimate wave higher or during the right shoulder rally are now facing significant losses because they were incorrect; consequently, they will now sell their positions, which will push the price in the direction of the profit target.

The right shoulder is a lower high than the head, so placing a stop above it makes sense because the trend has reversed and it is unlikely that the right shoulder will be broken until the uptrend resumes.

The profit objective is predicated on the notion that individuals who made mistakes or purchased the security at an unfavorable time will be forced to sell, resulting in a reversal of comparable magnitude to the recently formed topping pattern.

Numerous traders will feel pressure at the neckline and will be compelled to close positions, which will drive the price toward the price objective.

Volume can also be observed. We would prefer the volume to increase as an inverse head-and-shoulders formation breaks out (market bottoms).

As a result of the increased purchasing activity, the price will approach the target. The decline in volume suggests a lack of enthusiasm for the upward trend and calls for skepticism.

Advantages

It is readily identifiable by seasoned traders.

Stop distance, entry levels, and confirmation openings and closings are all precisely determinable.

Due to the lengthy duration of a head and shoulders pattern, a market's movement from the entry price to the closing price could be substantial.

The pattern applies to all markets, including stock trading and foreign exchange.

Disadvantages

Beginner investors may overlook it: This can confuse beginner traders.

It is possible to attain large stopping distances if there is a significant downhill movement over an extended period of time.

If the price retraces, the neckline may be retested, which could confuse some traders. Alternatively, the neckline may move.