Trading with the Head and Shoulders Pattern on the Chart

Hello, this is Bitpunk. Today we'll look at the head and shoulders pattern, one of the patterns that appears most often when trading assets like Bitcoin. The head and shoulders pattern shows up very frequently, so understanding this pattern alone can help you earn decent profits.

What Is a Head and Shoulders?

A head and shoulders usually looks like the image below. The key parts are the head in the middle and the shoulders on either side. Typically, volume is highest at the left shoulder and gradually decreases as you move to the right.

Gradually decreasing volume also means the trend is weakening. The head and shoulders pattern usually forms when an uptrend has been going on and the trend is about to reverse.

In short, the head and shoulders pattern is a pattern that signals a possible trend reversal as volume declines near the end of a bull market.

Entering a Short with the Head and Shoulders

So how can you trade using the head and shoulders pattern? Before you start trading in earnest, there are some things you must keep in mind. The first is that you have to wait until the pattern is complete. It's important not to anticipate the pattern's completion, but to wait patiently.

So what does it mean for the pattern to be complete? It means the head and shoulders are fully drawn on the chart and the price starts falling below the neckline!

What is the neckline? Take a look at the chart below. The neckline refers to the bottom area of the head and shoulders. As in the chart below, can you see an imaginary support line that holds while both shoulders are being formed? That's the neckline. The moment this line breaks is the moment the head and shoulders is complete!

Once the head and shoulders pattern is complete like this, you can enter a short. However, at this point you should also look at the strength of the decline and the volume. If the downward momentum is strong and heavy volume comes in, the price is more likely to fall significantly.

Take-Profit and Stop-Loss Points

If you've entered a short as the head and shoulders pattern completes, you may be wondering where to take profit and, just in case, where to set your stop loss.

First, you can take profit around a point the same distance below the neckline as the head is above it. In other words, if the distance from the neckline to the head is 30P, you can consider taking profit at a point 30P below the neckline.

What you need to be careful about here is to make sure you take profit without getting too greedy. Because the head and shoulders pattern appears in a bull market, the price often rebounds all the way back to around the neckline and then continues rising again. When trading with the head and shoulders pattern, don't forget: taking profit is always right!

Next, you can set your stop loss at the high of the candle just before the point where the neckline breaks as the head and shoulders pattern completes. If you're not familiar with stop losses, check out the detailed guide on how to use a stop loss.

Head and Shoulders: Final Summary

By now, I think you have a good understanding of the head and shoulders pattern. The head and shoulders pattern has a very high success rate and mainly appears near the end of a bull market. When entering a short using the head and shoulders pattern, don't forget to wait until the pattern is complete. Enter your short while watching momentum and volume as the neckline breaks, and carry out your take-profit and stop loss according to plan.