The Head and Shoulders Continuation Pattern

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Head And Shoulders Pattern Trading Guide (In-Depth)

The head and shoulders pattern has a memorable name and a striking look.

But the quote below confirms that the head and shoulders pattern is more than just a cute pattern. It offers real value to traders.

Head-and-shoulders tops are the best performing bearish chart pattern in a bull market.

Introduction

This guide, chocked full of practical chart examples, covers everything you need to know about this high performing pattern: head and shoulders.

To avoid confusion, the explanation in this guide is for the head and shoulders top pattern. It is a bearish reversal formation.

Its bullish equivalent is the head and shoulders bottom (inverse head and shoulders).

Familiarize yourself with the head and shoulders pattern. Then, you can apply the same logic to find and trade inverse head and shoulders.

Head And Shoulders Guide Overview

This comprehensive guide covers both the core and advanced concepts of the head and shoulders pattern.

Depending on your experience with this pattern, you may like to navigate directly to the sections that interest you.

#1: How To Identify The Head And Shoulders

Essential Parts

This diagram shows the key traits of a head and shoulders formation. Below it, you will find a list elaborating on each aspect.

#1: Left Shoulder

  • Must be the highest point of the current bull trend at the point of its formation

#2: Left Valley

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#3: Head

  • Must make a new high in the bull trend
  • Must be the higher than the left shoulder

#4: Right Valley

  • Must be lower than the left shoulder

#5: Right Shoulder

  • Must be in between the head and the left valley

#6: Neckline

  • Connect the left and right valleys to form the neckline
  • The market must break below the neckline to confirm the head and shoulders. If the market rises above the head before breaking the neckline, the pattern becomes invalid.

Practical Tip For Finding Head and Shoulders

A head and shoulders pattern stands out on a chart. It looks like a head with shoulders.

And the shoulders must overlap. (#4 and #5 above made sure of that.)

Hence, an efficient way to find head and shoulders is to scan your charts for an outstanding head and overlapping shoulders.

Then, take a closer look to see if they fulfill the pattern criteria above.

#2: Classic Head And Shoulders Trading Rules

The classic head and shoulders pattern triggers a bearish reversal trade. Hence, a current bull trend is necessary.

1. Make sure that the market is in an uptrend. (You should have a bull trend line intact.)

2. Enter when price breaks below the neckline.

3. Place your stop-loss above the right shoulder.

4. Measure the distance between the head and the neckline (X).

5. Project the distance (X) down from the neckline. Place your target limit order there.

#3: Head And Shoulders – Why Does It Work?

We will never know the exact reason for why each pattern works.

But it’s useful to think of the pattern formation as a struggle between buyers and sellers.

The head is higher than the left shoulder. It empowers the buyers and gives them the confidence to enter the market.

However, when the right shoulder forms, it is lower than the head. It represents the failure of the market to continue the trend upwards.

Of course, this inability to resume the trend is not enough to justify a trade. The buyers are disappointed but have not given up. However, the uncertain buyers get the jitters. They are fearful and become sensitive to the price action that comes next.

In this context, the neckline becomes a critical support level. Its failure will cause the buyers’ fear to swell. They will start selling, and more sellers will join in, causing a market reversal.

#4: Advanced Trading Insights For The Head And Shoulders Pattern

As with every price pattern, there are nuances you can only learn through experience. Hence, from here on, you will see real chart examples, and not the earlier textbook diagrams.

These insights will accelerate your progress. But remember, they are mere guidelines. Apply with discretion.

#4.1: Entry Methods

You should always wait for a neckline break to trigger a position.

Entering earlier might make sense for continuation setups. However, a head and shoulders pattern often targets a significant reversal.

When gunning for a shift in the market bias, an earlier entry is unlikely to compensate for the lower probability. Further confirmation is always helpful.

According to your level of confidence, you can vary your entry trigger. Instead of entering right after the market breaks the neckline, consider these triggers.

Wait for a decisive break of the neckline. You can look for a price bar close below the neckline to confirm a breakout.

Wait for a retest of the neckline to enter. When the neckline is broken, it flips from support to resistance. Hence, you may go short when the market pulls back to retest the neckline as resistance.

However, many neckline breaks are followed by a sudden fall with no retest. Thus, you must be prepared to miss some of the best head and shoulders setups.

If not, you may consider a half and half strategy. Enter with half of your position size on the breakout of the neckline. Then, if there’s a retest of the neckline, enter the market with the remaining half. This approach ensures that you get on board a runaway plummeting market.

When the neckline is sloping down, it is not an ideal trigger. The market has to fall more before it can break a downward sloping neckline. This implies that it’s offering a delayed entry.

Hence, some traders choose to skip head and shoulders with downwards sloping necklines. I advise doing the same if the neckline has a steep downslope.

For a neckline with a slight downslope, you can trade them if there other supportive factors. In fact, some traders find that the pattern works better when the neckline slope is down.

If you choose to trade them, consider using the right valley as your trigger price.

#4.2: Stop Loss Placement

The classic stop loss for a head and shoulders is just above the right shoulder.

However, for many cases, this convention will produce a wide stop.

When the stop loss implied by the right shoulder is too wide, it makes sense to place a tighter stop. At the same time, use a systematic strategy for re-entering the trade.

There are many logical ways for you to tighten the stop-loss order.

You may use a bearish price pattern or a closest swing high to place your stop loss. A volatility stop loss works too.

The example below shows a swing high as an option for a tighter stop loss.

The most aggressive exit strategy is one based on strategy invalidation. When the market closes above the neckline, the pattern is deemed invalid, and the position is closed.

However, this approach might push you out of good trades due to minor whipsaws. Hence, consider a re-entry if the price action is favorable.

#4.3: Target Price

The projected target of a head and shoulders pattern is a theoretical minimum. In practice, treat it as a draft target to work with before integrating other information.

It’s important to look for significant support that might impede the falling momentum. Check if any critical support exists between the head and shoulders pattern and the target. If so, don’t stick stubbornly to the target price.

An equally relevant factor is confluence. This concept refers to the overlap of results from different observations. If the projected target price falls within a support zone, accord greater weight to it.

In the example above, the projected target fell within a congestion zone support area. Hence, it was an excellent target for this trade. (Congestion zones are taught in my trading course as a way to identify support and resistance.)

Remember that your target can be fluid. If the market stalls and forms prolonged congestion, you can exit at the market price. You need not wait for your target price to be hit.

#4.4: Volume Considerations

The neckline break should occur with a volume surge. This is a critical factor for high-quality patterns. It works well as a filter to remove low-quality setups.

You can identify the volume surge with a volume overlay or with the help of a volume indicator like the OBV.

In the example below, the volume surge was subtle but meaningful. You do not see a significant one-bar volume spike. Instead, the volume rose steadily as the market fell to break the neckline. This shows that the bears were gaining strength.

(The bar-on-bar volume changes is highlighted by the Chart Background Color Indicator. Green means increasing volume, and red means decreasing volume.)

The volume pattern before the neckline break is less important than the volume at the neckline break. But it’s still useful to apply the following guidelines in your analysis.

  • If the head shows less volume (compared to the left shoulder), it signals a lack of interest in the bullish trend.
  • If the head forms with extremely high volume, it might be a sign of exhaustion. (See Anchor Bar and Stopping Volume.)

#4.5: Reversal Trading Tips

Before you think of a reversal trade, you must first find a trend to reverse.

An efficient way to do this is to employ a stock scan. There are two basic scans you can use for this.

  • High ADX Values
  • X Day Above The X Period EMA (e.g. 50 Days Above The 50 EMA)

With these scans, you can start building a watchlist of bullish stocks. You can then check them periodically to find potential head and shoulders patterns.

As head and shoulders patterns take some time to form, you need not check each chart daily. Frequent reviews are necessary only after the formation of the right valley.

Consider looking for an indicator divergence to confirm the reversal. Bearish divergence and a head and shoulders pattern form a potent reversal recipe.

The example below shows a head and shoulders pattern with a MACD bearish divergence.

Look for markets that had a powerful and swift rise before forming a head and shoulders pattern. The subsequent reversal is likely to be potent as well.

However, a major trend reversal requires a significant head and shoulders pattern. To reverse a strong bull trend, you should look for a head and shoulders pattern that forms over a longer period. In such cases, waiting a few weeks for a pattern to complete is common.

You’ll learn that patience is the key to trading head and shoulders patterns.

#4.6: Continuation Trading Possibility

Head and shoulders is a reversal pattern by convention. But that does not mean that you cannot use it for continuation/pullback trades.

A mini head and shoulders formation is a potential trigger for a pullback trade.

Look at the example below.

In this example, the market was in a bearish trend. The pullback to the 20-period EMA also formed a small head and shoulders pattern.

Here, the neckline break was the perfect trigger for a bearish pullback trade.

#4.7: Best Pattern Form Guidelines

These are guidelines with regards to how the ideal head and shoulders should look like. While they are helpful when you are choosing among patterns, don’t get obsessed with them. Reading the market context is more important than finding the perfect pattern.

Give more weight to head and shoulders patterns with upsloping necklines.

When the right shoulder is lower than the left shoulder, consider it a sign of greater profit potential.

Some traders get mired in geometry. They think of symmetrical patterns as superior. But according to research by Thomas Bulkowski, “symmetrical looking patterns perform worse.”

Trend Line Interaction

Do you use trend lines to track the market?

If so, pay attention to how the head and shoulders pattern interacts with the trend line.

  1. This is a bull trend line tracking the current trend.
  2. The right valley broke the trend line, implying that the trend has weakened.
  3. This retest of the broken bull trend line as resistance led to the formation of the right shoulder.

This example shows that you can confirm the high quality of a head and shoulders pattern with a trend line.

#4.8: Miscellaneous Tips

In theory, chart patterns like the head and shoulders work for traders of all time frames.

But in practice, the most powerful head and shoulders patterns take longer to form. Hence, most traders focus on daily and weekly charts to find head and shoulders.

Note that the bullish version (inverse head and shoulders) takes even longer to form. This is a general observation that applies to bottoming patterns. It takes more time to reverse a falling market.

#5: Head and Shoulders – Potential Pitfalls To Avoid

Don’t get fixated on the label of the head and shoulders pattern. The name of the pattern is not important except for kickstarting your education. You can often interpret the best setups through different patterns and concepts.

(Take a look at the triple top pattern. You’ll see this when the pattern head is so low that it’s close to the two shoulders.)

Recognize that all chart patterns are a combination of swing pivots and trend lines. In the case of the head and shoulders, it’s the combination of three swing highs, two swing lows, and a neckline.

Hence, as you gain experience, define your own rules for identifying swings and chart patterns like the head and shoulders.

(Note to course students: If you look for a tested high to be the right shoulder, it will become a valid high after the neckline break. This will enhance the pattern and give you a basis for drawing a new trend line.)

Define my own rules?

Yes, you can deviate from the classic rules. Just make sure you stay consistent. This is the best way to avoid the confusion that chart patterns present at times.

For this, I think Jim from Trading-Naked got it right. He wrote:

I have received many emails and posts on yahoo groups telling me my pattern is not a Head and Shoulder. Ok, I agree perhaps some are different from traditional definitions. Those that write books on technical analysis have their definitions. I massage those definitions and create my definitions.

After all, you are the one trading your account, not the authors of the technical analysis textbooks.

Don’t feel compelled to trade every head and shoulders pattern you find. Take only the best trades. This advice is especially important for reversal trades. Reversal setups make sense because of their high profit potential. So don’t settle for a setup that has a weak reward-to-risk ratio.

You need not always trade a pattern. You can also use a chart pattern for analysis.

For instance, a well-formed head and shoulders failed to reverse a bullish trend.

What does this failure imply? What does it tell you about the current price action?

Finally, remember that the head and shoulders is just a chart pattern. It is a useful tool, but it does not define the market.

21 – Head and Shoulder continuation pattern I

charts via tradingview.com Voice transcript And hello. Welcome back. Let’s continue with the beauty of head and shoulders patterns. And now we are going to look at continuations. Because head and shoulders are not only reversal patterns, but they can also be continuations.And in this example, you can already see that it does look a […]

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Head and Shoulders

Predictions and Analysis

Head and Shoulders

The Head and Shoulders pattern is an accurate reversal pattern that can be used to enter a bearish position after a bullish trend. It consists of 3 tops with a higher high in the middle, called the head. The line connecting the 2 valleys is the neckline. The height of the last top can be higher than the first, but not higher than the head. In other words, the price tried to make a higher high, but failed. The closer the 2 outer tops are to the same price, the more accurate the pattern.

If the price breaks the neckline and closes below it, the pattern has completed. Conservative traders may look for additional confirmation. The target can be estimated by measuring the height of the pattern (from the neckline to the head) and projecting this downwards. Common stop levels are above the neckline or above the right shoulder. The Inverse Head and Shoulders is the bullish version of this pattern that can form after a downtrend. TradingView has a smart drawing tool that allows users to visually identify this pattern on a chart.

Multiple Ways to Trade the Head and Shoulders Chart Pattern

The head and shoulders is a common technical analysis reversal pattern, showing that the price trajectory of an asset may be changing. Learn the pros and cons of the pattern, how it can be used for analysis and some different ways to trade it. Also, learn about the not-often-discussed head and shoulders continuation pattern.

Price is the ultimate indicator. It always shows when a reversal is under way. A reversal is a transition from an uptrend to a downtrend, or vice versa. While price always eventually reveals the reversal, there are patterns that highlight when it is starting. The head and shoulders pattern is one of those patterns. The pattern itself actually represents the transitions from uptrend to downtrend (and an inverse head and shoulders pattern shows the transition from downtrend to uptrend).

Head and shoulders chart patterns occur in all markets, and on all time frames. Here’s what it looks like, how it is interpreted and ultimately how it can be traded. The “usual” way to trade it is discussed, as well as some alternate ways. I am not a big fan of the “text book” way to trade it, because if we really understand the pattern then there are some better entry points we can look for. That said, the head and shoulders doesn’t need to be traded, but it is a good pattern to know since it alerts us whether we should be changing our view on the market (favoring longs before the pattern, and favoring shorts after the pattern, or vice versa for an inverse pattern).

How to Interpret the Head and Shoulders Chart Pattern

The head and shoulders pattern signals a reversal because it shows an uptrend is likely over. The pattern is created by the price rallying into a first high (left shoulder), then pulling back (left armpit), rallying to a new high (head), pulling back (right armpit), rallying to a lower high than the head (right shoulder) and the proceeding to drop again. Here’s what it looks like on a chart.

Figure 1. Head and Shoulders Chart Pattern on NZD/USD 30 Minute Chart

A trendline connects the left armpit low to the right armpit low, forming a neckline. After the right shoulder has formed, if the price drops below the neckline the pattern is considered complete, and a reversal is underway. Occasionally the neckline won’t be of use, because it is angled too steeply (either up or down) to provide a viable signal. When this occur, use the right armpit low as an alternative. If the price drops below the neckline, or the right armpit low, consider the pattern complete. By “complete” I mean that the reversal is in place, indicating that a downtrend is underway and the price is likely to head lower, overall (opposite for an inverse pattern).

Waiting for the pattern complete indicates that a trend reversal is already underway. But we can actually see evidence of a reversal earlier. This is especially true when the head and shoulders takes on a certain shape. For example, the right armpit may be lower than the left. When this occurs the price has already created a lower low (right armpit is below left armpit). A lower swing low is a sign of a downtrend, not an uptrend. So if the price makes a lower low, and then rallies and makes a lower high (right shoulder)–and then starts dropping again–we have two key pieces of evidence that a downtrend is underway (lower high and lower low). We have this evidence before the pattern completes. Once the patterns completes, or the price drops below the right armpit, we have even more evidence that the downtrend is underway…or at minimum that the uptrend is in trouble and we should stay away from buying for the time being. We will talk more about buying and selling based on this pattern a bit later.

The key is not to think about the pattern specifically. Understand what the pattern is telling us. People have a tendency to get very caught up in a how a pattern looks, but that is not the important part. What we are really watching is that transition from uptrend to downtrend. Since uptrends make overall higher swing lows and higher swing highs, when we start to see lower swing highs and lows, that tells us the trend is in trouble. The head and shoulders pattern is simply a way to visualize that transition.

If the right armpit is higher than the left armpit, then we need to wait for pattern to complete, because in this case we don’t have a lower swing low during the pattern. The right shoulder will form a lower swing high, but until the price starts dropping again it is a bit pre-mature to start calling it a downtrend. Notice the difference? If the right armpit is below the left, and then forms the right shoulder, we have both a lower swing high and a lower swing low. But if the right armpit is above the left armpit, then we only have the lower swing high on the right shoulder to tell us the downtrend is starting…in others words, there is less evidence in this case so we may want to wait for the pattern to complete before considering it a downtrend.

Here is an example of the right armpit being lower than the left armpit. By connecting all the swing highs and lows with lines we can see the uptrend, and also the transition to the downtrend. When you are starting out in trading, this is a good exercise to do because it highlights the changing trajectory of the price very well. On this type of pattern we have a lot of evidence of a reversal before the pattern completes. As the price is moving down toward the completion point the price has already made a lower swing low and lower swing high. As we will discuss later, having that knowledge a bit earlier than most other people (who are just focused on the pattern, and not really understanding what is happening while it is forming) will provide better entry points–and that means trades with smaller risk and greater profit potential.

Figure 2. Head and Shoulders on GBP/USD Weekly Chart

Ways to Trade the Head and Shoulders Pattern

First, let’s look at the textbook way to trade the head and shoulders pattern. While it is viable, it is not my favorite way to take advantage of this type of price movement.

Take a short trade when the head and shoulders chart pattern completes (price breaks below right armpit low or neckline). Place a stop loss order just above the right shoulder. Calculate a target for the trade by measuring the height of the pattern (high of the head to low of the armpit(s)), and subtracting it from the breakout price. In figure 1, take the difference between 0.8395, which is the head, and the low of the pattern at 0.8370, which is the low of the armpits, to get a height of 25 pips. Subtract this height from 0.8370, the breakout price, to get a target of 0.8345.

The risk of course is that price moves higher again, above the right shoulder, hitting the stop loss. One good thing about the head and shoulders is that the reward to risk is favorable. Since the profit target is based on the entire pattern, and the risk is based on the right shoulder, the profit potential is always greater than the risk.

Use a bit of common sense when trading the head and shoulders pattern. If there is a huge head and shoulders pattern due to some rare news event, then the profit target may not be reached since the volatility that created the head and shoulders is likely to dissipate. If we base profit targets on volatile and rare events, then we basically need another volatile and rare event to trigger a move big enough to reach our target.

Figure 2 had a high of 2.1161 and a right armpit low of 1.9337 (shown again in Fig. 3). A pretty big pattern: 1824 pips high. Remember, this is a weekly chart, and these patterns occur on all time frames. The armpit low is also the breakout point, so a short trade is entered when the price moves below that level. A profit target is placed at 1.9337-0.1824 = 1.7513. The stop loss is placed above the right shoulder. In this case, before the currency breaks lower the price actually forms two right shoulders. The stop loss goes just above the lower shoulder (S2), at approximately 2.02 (if we entered on the first shoulder, our stop loss would go above that, but could be dropped to just above S2 after it forms and the price starts dropping again). That is 863 pips of risk, but our reward potential is 1824 pips. So it doesn’t necessarily matter what time frame is being used, the important thing to remember is that we want our profit potential to outweigh our risk.

Figure 3. Trading Classic Head and Shoulders on GBPUSD Weekly Chart

The classic way to trade the head and shoulders pattern always provides an entry point, assuming the price drops below the right armpit or neckline.

The next way to trade the pattern won’t always provide a signal. The next way requires a few more things to occur. In other words, for trading purposes, I want the patterns I trade to go through a more thorough filtering process.

The way I like to trade the head and shoulders is to short sell as the left shoulder is forming. The stop loss is placed in the same position, and the target is also calculated the same.

The things that change are how and where we get in. Also, the right armpit must drop below the left armpit or be of similar level to the the left armpit (remember, this gives a bit of extra evidence of a reversal while the pattern is forming). For more on why this is, see Strong Trend Reversal Strategy.

Assuming the right armpit is below the left (or the two are at similar levels), as the price starts to rise into the right shoulder we can watch for a couple early entry signals. I like to watch for the price to consolidate (move sideways for several price bars), at a lower high than the head, and then enter a short trade when the price drops below the low of the consolidation. Alternatively, a bearish engulfing candlestick pattern can be used as an entry signal.

Figure 4. Alternate Strategy for Head and Shoulders on USDJPY Daily Chart

Numbers are not even required to show the difference between the alternate method and the classic method. Our entry point in this case is way above the classic entry point. This means our entry is closer to our stop loss, which means our profit potential is going to be much bigger relative to the risk we are taking on.

The drawback of this strategy is that it takes more practice than the classic method. We have to be able to see the pattern forming before it is completes. We need to make the assessment of whether the trend is actually turning to the downside. Then, we need to be patient enough to wait for the consolidation and a breakout to the downside, or a bearish engulfing pattern (during the right shoulder). This is a more advanced trade.

Since this alternate method is more stringent, it doesn’t occur as often as the classic entry method. Although, the alternate method typically provides a way better reward:risk ratio, therefore it typically pays to be more stringent.

How to Trade the Inverse Head and Shoulders Chart Pattern

An inverse head and shoulders has the same structure as discussed above, except it is flipped upside down.

Figure 5. Inverse Head and Shoulders Chart Pattern on GBP/JPY Daily Chart

The inverse pattern is traded in the same way. The traditional method is to buy when the price breaks above the neckline of the inverse pattern (or the right armpit high if the neckline is too angled to be relevant). Place a stop loss order below the right shoulder. Find the difference between the high and low of the pattern, and then add that distance to the breakout price to attain a target price for the trade.

Another option is to go long once the right shoulder makes a higher low than the head, and then starts moving higher again. I prefer this method when the left armpit is almost as high, or preferably higher, than the right armpit. I like to watch for a consolidation to form during the right shoulder, and then enter long when the price breaks above the consolidation high. Bullish engulfing patterns are also a viable entry signal. These alternative entries will result in a lower entry price than the neckline method, which results in a better reward:risk ratio.

In figure 5 we have a right armpit that almost reaches the left armpit (think about what that tells you about how the strength of selling has diminished). Then on the right shoulder, we have a strong upside (green) candle signaling the price is moving back up. It isn’t a perfect engulfing pattern, but it does show the strong transition back to the upside. This is a potential entry. The price also moved sideways for a period after that, so a long trade could have been taken when the price broke above that consolidation. Both these entry points would have gotten a trader in at a better price compared to waiting for the neckline breakout.

Use the same stop loss location and target estimate for both methods.

Head and Shoulders Continuation Pattern

Initially, I said that a head and shoulders is a reversal pattern, but not always the case. As with everything in trading, it depends on context.

What I have found is that reversal patterns are at least as large as the typical price wave in the trend that precedes it.

If the pattern looks very small compared to the price waves around it, it very well could be a continuation pattern. For example, if the trend is up (with big price waves to the upside) and then a small head and shoulders forms, it is actually quite likely the price could continue higher overall, instead of reversing.

Figures 1, 2, 3 and 4 all show head and shoulders that fit within the context of a reversal. Why? Because the down moves in the pattern are at least as big as some of the recent moves to the upside. One very important element to chart analysis is what I call velocity and magnitude. If you have big waves to the upside, and then small waves to the downside, that indicates that the trend is likely to continue higher. To reverse a trend, you need waves to the downside that are equal or greater in size than the up waves (notice how this relates to the alternate trading methods mentioned above?).

So if you have big up waves, and then a little head and shoulders chart pattern, there is no power in the pattern to reverse the trend (it may, on occasion, or temporarily, but until we get big down waves we must give respect to the uptrend and assume it is going to continue).

The same is true of downtrends. If we have strong waves down, and then a small head and shoulders forms, it is quite likely that the price could keep heading lower. The small pattern doesn’t show enough conviction on the part of the buyers to reverse the strong selling. As the pattern forms, it is more likely to eventually give way to more selling.

Here is an example of an inverse head and shoulders continuation pattern. The price is dropping aggressively. The entire pattern is only about half the size of the last drop. The price forms the inverse head and shoulders (many people would think this would point to a reversal back to the upside), but the price stalls and then plummets again.

Figure 6. Inverse Head and Shoulders Continuation Pattern on EURUSD 1-minute Chart There are no definitive rules for determining whether a head and shoulders is a continuation pattern or a reversal pattern. But in my experience, continuation patterns appear small relative to the price moves around them. The entire continuation pattern is more of just a sideways period where the market takes a bit of a rest from the current trend, but then the trend continues. A reversal pattern is larger and more forceful. It shows an overall transition before uptrend to downtrend, or vice versa. Focus on the size of the waves in the pattern compared to the size of the waves in the trend preceding it.

How to trade a continuation pattern? In figure 6 we can see strong downward movement heading into the pattern. The price forms the inverse head and shoulders, tries to go up, but quickly fails. There are multiple ways to get into this trade. One way would be to enter short when the price drops below the right shoulder low. A stop loss goes above the recent swing high. We are expecting the price to drop, and it will likely drop by the size of the pattern (or more). So take the height to the pattern, deduct it from the low and that gives an approximate profit target.

Same thing if the trend is up. In this case, we have strong upward movement into a small head and shoulders. If the price starts rallying above armpits or shoulders, BUY, and place a stop loss below the recent swing low. I say armpits or shoulders, because you could have an inverse or normal continuation head and shoulders patterns in both uptrends and/or downtrends.

The Final Word on Trading the Head and Shoulders

The head and shoulders chart pattern is one of the most popular chart patterns around. It’s easy to spot, but is really just showing a transition from an uptrend to a downtrend. Understanding the transition–the higher highs on the left side of the pattern to lower highs on the right side of the pattern–is the key take away here. Trade the head and shoulders in the traditional way, waiting for a break below the neckline, or trade it using the alternate approach. The alternate approach requires more experience at reading trends, and requires an entry once the price forms the right shoulder and then begins to drop again. Practice spotting these patterns and then test out which entry method works better for you in a demo account.

Inverse head and shoulders are traded in a similar way, except occur after a market decline, and indicate the trend is turning higher. All chart patterns are fallible and losing trades will occur, this is why a stop loss is used on all positions.

Continuations occur within a trend, and indicate a continuation instead of a reversal. I have found that continuation patterns are smaller relative to the price waves around them.

For more on trading chart patterns and other forex trading strategies, check out my Forex Trading Strategies Guide for Day and Swing Traders .

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