One of the very important and highly accurate pricing models is Head and shoulders model. This model is not only applied effectively in the forex and stock market, but also for the virtual money market, Binary Option…. Every time it appeared on the stock price chart, the market trembled. However, in the forex market, it is an opportunity to enter the sell order, because in forex trading, buying and selling only has relative meaning. So What is the head and shoulders pattern? How to identify exactly and how to deal most effectively?
What is the head and shoulders model?
The head and shoulders pattern is a price chart pattern that has the shape of a peak in the middle and two lower peaks on the sides. The low peak on the left is called the "left shoulder" (left shoulder). The low right side is called the "right shoulder" (right shoulder). The highest peak in the middle is called the "head" (head). When appended lowest point between right shoulder - head and lowest point between left shoulder - head will form a line called a "neckline". The neckline can be a horizontal line, or a little up or down.
This is an important reversal pattern. It is usually at the end of an uptrend. When this pattern appears in an uptrend, it is a strong signal that signals a trend to reverse from up to down. However there are a few rare cases, this pattern may appear in the middle of a trend.
Of course, there are always reversal patterns in market price patterns. So in addition to the dominant head and shoulders pattern, there is also the inverse head and shoulders pattern. The inverted head and shoulders pattern is at the bottom of a downtrend. When it appears, it's a sign that the trend is about to reverse from bearish to bullish. This is a good signal for those who want to buy stocks. And also a good entry opportunity for forex investors.
Important note with the head and shoulders model
The above section only briefly describes the head and shoulders model. However, this model has many variants. For example, the left shoulder may be higher or lower than the right shoulder. The neckline can be up or down ... The question is, in which case is the model more effective? Here is the answer for you:
- If the right shoulder is lower than the left shoulder, the model works. The strong signal indicates that the trend is about to reverse from up to down.
- The lower the neck curve, the more effective the model.
- If the top of the right shoulder is a strong reversal candlestick pattern like Pin bar, Doji, or Evening Star…. The high probability is that the price will break below the neckline and the trend will reverse.
- If the shoulders are well-proportioned, the top of the head and the shoulders are arched evenly, the pattern becomes more clear and effective than the pointed peaks.
- If you connect a line from the left shoulder to the right. Then if the price crosses this line and then suddenly returns sharply, there is a high chance that the trend will reverse.
- Even if the right shoulder is formed, the price has gone down past the neck line, it is still not sure that the trend will reverse. Then the price will usually retest the neckline again. If the test succeeds, the confirmation is more likely that the trend will reverse. See the picture below:
Method of dealing with the head and shoulders model
In this article, I will show you how to deal with the head and shoulders model. The inverse head and shoulders model is just the reverse case of the pros, so you know how to do it.
As you know, this is a trend reversal pattern from up to down. So when the head and shoulders pattern is formed, we must definitely sell. But the question is how effective is the selling strategy?
Trading strategy with a head and shoulders pattern on the stock market
When this model appears, if you do not hold stocks, it is best to stand outside the market.
In case you are holding stocks whose price chart has a head and shoulders pattern, you should consider selling.
- As soon as the "right shoulder" is formed, you should consider reducing the ownership of that stock.
- After forming the right shoulder and the price goes down past the neckline, you should consider reducing the stock rate further.
- After the price has passed the neckline and returned to test successfully, you should consider selling that stock.
The above suggestions are only for those who are short term investors or surfing. However, for long-term stock investors, once you have analyzed and determined that this is a good stock, you have available cash for long-term investment, you only need to reduce the ownership rate. stock down, wait for it to come down and buy again.
Trading strategy for a head and shoulders pattern in the forex market
The advantage of the forex market compared to the stock market is that you can buy first and sell later, or sell first to buy later. So even if you do not hold certain commodities or currency pairs in your account, then when the head and shoulders pattern appears, it creates an opportunity to sell down. The question is, how does the best selling strategy work?
- Once the right shoulder is formed, you should consider a small sell order. Because the pattern is not yet formed, the probability of trend reversal is not high, so you should only sell a small order. And don't forget to set the stop loss command above the top of the right shoulder. When placing a sell order at this point you are most profitable because you sell at a bargain price. And if unfortunately the price does not reverse but go up, you will not suffer a lot of losses.
- When prices break out down through the neckline, a head and shoulders pattern has formed. At this time, the probability of price reversal going down is very high, you place a second small sell order. And do not forget to place the stop loss at the interval between the neck line and the top of the right shoulder.
- After the price has broken through the neckline and returned to the test. If the test price is successful and going down, you can now place a big order. Because after the test is successful, the probability is high that the trend will reverse. And do not forget to place a stop loss order between the neckline and the top of the right shoulder.
For the best trading method, I recommend reading the following two articles:
Model of head and shoulders in practice.
In the description above, we have only seen the basic characteristics to identify a head and shoulders pattern. However, the actual price charts are often very complex, it's not always easy to identify the models. It also requires practical thinking and experience.
Here are a few realistic models for you to look at:
Figure below: A head and shoulders model is not really obvious and has an "extra head"
Lower picture: The left shoulder is higher than the right shoulder
Figure below: The shoulders are not symmetrical
Figure: Right shoulder with many vertices
Figure below: Neckline slopes upward
The picture below: The model has an uptrend line and is in a downtrend
Figure below: Reverse head and shoulders model in practice
Author: Pham Khuong
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