This guide on Head and Shoulders trading patterns explains how the patterns are used by traders and when the patterns may indicate potential buy or sell signals.
Contents
We explain the difference between Head and Shoulders patterns and Reverse Head and Shoulders patterns, along with the components of the pattern as seen on a chart.
What Is A Head And Shoulder Chart Pattern?
The Head and Shoulders chart pattern is a heavily used charting pattern, giving easily understood potential buy and sell signals.
The chart of Home Depot (HD) below shows a Head and Shoulders pattern:
Components Of A Head and Shoulder Pattern
These are the main components of a head and shoulder chart pattern:
- Left Shoulder: Bulls push prices upwards making new highs; however these new highs are short-lived and prices retreat.
- Head: Prices don’t retreat for long because bulls make another run, this time succeeding and surpassing the previous high; a bullish sign. Prices retreat again, only to find support yet again.
- Right Shoulder: The bulls push higher again, but this time fails to make a higher high. This is very bearish because bears did not allow the bulls to make a new higher or even an equal high. The bears push prices back to support (Confirmation line); this is a pivotal moment. Bulls may make another push or the bears may stop the upward trend.
Sell Signals From H&S Patterns
If prices break the confirmation support line, it is clear that the bears are in charge; thus, when price closes below the confirmation line, a potential sell signal is given.
Note that a downward sloping confirmation line is generally seen as a more powerful Head & Shoulders pattern, mainly because a downward sloping confirmation line means that prices are making lower lows.
Reverse Head and Shoulders Components
The opposite of the Head & Shoulders pattern is the Reverse Head & Shoulders pattern which is another strong pattern, this time a bottoming pattern.
The reasoning behind a Head & Shoulders pattern is as follows:
- Left Shoulder: Bears push prices downwards making new lows; however, bulls begin to return and push prices slightly higher.
- Head: Price gains don’t last long before bears return and push prices even lower than before; a bearish sign. Prices then find buyers at the new lower prices.
- Right Shoulder: The bears push downward again, but this time fails to make a lower low. This is generally seen as a bullish sign, bears were unable to push prices further down. Decision time occurs when the price is pushed higher back to support (Confirmation line); either bears will push prices back down or bulls will push prices higher, regaining control of the stock, future, or currency pair.
Buy Signals From Reverse H&S Patterns
When the price closes above the confirmation line, a potential signal is given.
Usually, an upward sloping confirmation line is seen as a more powerful Reverse Head & Shoulders pattern, mainly because an upward sloping confirmation line means that prices are making higher highs.
Volume analysis is important when using the Head & Shoulders chart pattern. How to incorporate volume into the study of the Head & Shoulders pattern is discussed next.
How Does The H&S Pattern Impact Volume?
When the confirmation line of a Head & Shoulders pattern breaks to the downside, a large amount of volume should occur as well.
The chart below of General Electric (GE) shows a sharp increase in volume when the confirmation line of the Head & Shoulders pattern was broken:
In addition to the sharp increase in volume, the gap down on the chart of GE also gave strong indication to potentially sell when the confirmation line was pierced.
The same concept applies to a Reverse Head & Shoulders pattern, the break of the confirmation line should be accompanied by an increase in volume.
Rising Volume With H&S Patterns
The chart below of Gold futures illustrates a rise in volume when the confirmation line was pierced:
Similarly, related chart patterns include the Double Top formation and the Double Bottom formation.
Where To Use Head & Shoulders Patterns
If you are interested in trading stocks and commodities using technical analysis, have a look at our reviews of these regulated brokers available in to learn which charting & analysis features they offer:
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74%-89% of retail investor accounts lose money when trading CFDs. You should consider whether you can afford to take the high risk of losing your money.
Further Reading and Resources
Learn more about technical analysis indicators, concepts, and strategies including Support & Resistance, Moving Averages, Fibonacci Patterns, and many others.
Also see our guides on Forex, Bitcoin, CFD, Stocks, Cryptocurrencies, and Options brokers to find out which technical analysis tools and platforms popular online trading brokerages offer their clients.
FAQs
Is a head and shoulders pattern bullish?
Standard head and shoulder patterns are an indicator of a sizable downward price reversal from a prior upward trend, so head and shoulder patterns are bearish. On the other hand, reverse, or inverse head and shoulder patterns indicate a bullish chart reversal from a downward trend to an upwards trend.
What does a head and shoulder pattern indicate?
The head and shoulders pattern’s characteristic ‘shoulders’ indicate two price peaks, between which a middle, highest peak stands. A middle peak between two shoulder peaks is a standard head and shoulders pattern, which is thought to indicate a downward price reversal of the stock, CFD, or instrument price.
