Hello and welome to another edition of the bulls vs the bears. Last time we kicked of our series on trading patterns by touching on How To Make the Most Out of Double Tops and Double Bottom Chart Patterns. Today we are going to learn how to ring in the cash trading the head and shoulders pattern. The head and shoulders pattern is a reversal occurrence that is spotted in the uptrend. – i.e when the bulls are in full steam.
Now I can imagine somebody asking”Why the Head and Shoulders Pattern?”Well, the pattern resembles a head and a pair of shoulders. The pattern kicks off with a high(Shoulder) on the chart. Price then creates a 2nd high(Head), even higher than the the first high. The bulls are definitely on a high. And it sure ain’t cocaine-induced. Guess what happens next? A third high(Shoulder) pops up on the chart. But this is a little lower than the second high, and it is on the same level as the first high.
So the long and short of this pattern is this. You have a peak(shoulder) followed by a higher peak(head) and then by a lower peak(shoulder). This adds up two one head and two shoulders
You then draw a neckline connecting the lowest points for the two troughs. Fortunately the slope of this neckline can be up or down. When the slope is down, a strong price signal is created. let’s see an illustration of the price action on the head and shoulders pattern
Ladies and gentlemen, here is the head and shoulders pattern in its majesty. The head is the second peak and highest point in the chart pattern. Notice how the two shoulders form peaks, but not exceeding the height of the head.
Now I can hear someone saying”Where do I place my sell order”? First place your sell order below the neckline. You then measure your profit target by measuring the highest point of the head to the neckline. This distance covers how far the bears will head down the slope. Let’s take a look at the price action
As you can see the the bears launch a huge spectacular breakout below neckline at slalom speed. The size of their breakout is similar to that of the distance between the head and the neckline. Now some of you may be saying “Hmmm…I wish this breakout lasts for ever.” Well, if only wishes were horses. Just don’t be greedy. Take your profits and run for dear life.
Now let’s look at the flip side.
Inverse Head and Shoulders
Inverse head and shoulders is another head and shoulders pattern. Except that this pattern is upside down. This formation takes shape after a long period of bearish domination. In other words the bulls take over after the bears run out of steam.
Here you have a valley(shoulder) followed by a lower valley(head), and then a higher valley. In other words, you have a higher trough, a lower trough and another higher trough.
Let’s take a look at how the price action plays out.
As you can see, this is just like the traditional head and shoulders. Except that it’s flipped upside down. With that in mind, you place your order to buy above the neckline.
And just like the head and shoulders pattern you calculate the profit target by measuring the high point of the head to the neckline. You’re measuring the the extent of the bears’ breakout after it cracks the neckline.
Let’s take a look at the bulls breaking through the neckline.
There you have it! Price, represented by the bulls , has blasted through the neckline and is heading towards your profit targets. So once the bullish convoy hits your take profit target, take your profits and run for dear life
However, you can use trade management techniques to lock in some profits and still keep your trading position open in case price continues in your trading direction.
For more information on trade management look up Expand Your Winning Position
That’s a wrap for “How To Ring In The Profits Trading The Head and Shoulders Pattern.” You can catch the head and shoulders pattern in the uptrend after the bears have been dominating for long periods. Once the bears run out of steam, then the bulls take over.
On the flip side you have the inverse head and shoulders which you can catch in the downtrend after a period of domination by the bulls. Once the bulls run out of steam, the bears take over.
Next time we will look at how to trade wedge chart patterns.
Til next time take care
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