Ultimate Guide to Head and Shoulders Pattern
The head and shoulders pattern is a visual formation on stock or a Bitcoin chart that resembles a neckline along with three peaks. The pattern occurs when the market is about to experience reversal either from a downtrend or uptrend. It is one of the widely used reversal candlestick patterns used by Altcoin and Bitcoin traders and continues to provide insightful information about market reversal.
The head and shoulders pattern usually occurs in a bullish market and signals the upcoming selling pressure. As its name suggests head and shoulders candlestick pattern, comprises four parts; The left shoulder, the head, the right shoulder or the neckline (support). It is one of the reliable candlestick patterns and has high degrees of accuracy.
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How head and shoulders pattern comes into formation?
The Left Shoulder
The pattern starts after the creation of a new high in underlying stock or Cryptocurrency. The volume here is noticeably high and bulls are in control of the price. After reaching the new peak, the price briefly declines to retest the support levels, in turn, creating the neckline. The buying pressure dries and sellers step in to take their profits. The fight between bulls and bears craft the left shoulder and any stock or Bitcoin trader can spot it on the charts.
The new buyer enters the market after the price has bottomed. The prices rally with higher volumes pushing Fear of Missing Out (FOMO) traders to step in the game. Bulls take control of the market and create a new high which is significantly bigger than the previous one. Eventually, price falls as Bitcoin traders short their positions and take their profits. Selling pressure increase and bears take over pushing the price back towards the neckline.
The Right Shoulder
Once price reaches the bottom, the buyers attempt to increase the price and push it to newer highs. However, this time, the buyers fail to push the price to newer highs since bulls are largely exhausted, and there is a high selling pressure from early buyers. Bears get dominant pushing the price to neckline before any considerable action. The war between buyers and sellers creates the right shoulder.
The neckline is the most important part of this pattern. It defines the support area and signals Bitcoin traders to short or long the asset. The neckline is the last defense for bulls to prevent a price downtrend. Once broken, the price falls and bears take full control of the market sending the price to make lower lows.
Why the pattern matters?
The head and shoulder candlestick pattern is a major reversal pattern. It takes at least two to three months to complete on a daily time frame. The pattern helps stock or Bitcoin trader to visualize a strong support level. It is useful to place a stop-loss order or exit from the market once the formation is complete. The head and shoulders pattern is an excellent opportunity and provides warning signs for investors sitting on a long position.
Inverse head and shoulders pattern
The opposite of this formation is the inverse head and shoulders pattern. It usually forms in a bear market and is opposite to the one above. The pattern is the same as head and shoulders pattern but, is inverted. The pattern signals a bullish trend reversal and newer highs. The formation is a good spot for long entry and is good to make quick profits. In the reversal head and shoulders candlestick pattern, a suitable profit target can be measured by calculating the distance from the head price to the neckline.
Key Notes of head and shoulders pattern
- The pattern is a visual pattern and is not an indicator. It resembles three peaks or lows, with the middle being the biggest in height.
- It is a reversal pattern and is good to make a long or short entry.
- Most of the time neckline is not straight and is usually tilted. The formation is also not perfectly shaped and sometimes shoulders are slightly upwards.
- One of the shoulders might be broader than the other causing confusion for stock or bitcoin traders.
Head and Shoulder Pattern in Practice
Let’s analyze an Altcoin chart and spot the inverse head and shoulders pattern formation. The image below shows the hourly chart of Litecoin depicting an inverse head and shoulders pattern. From the Crypto chart, we can see that the price of Litecoin was in a downtrend prior to head and shoulder formation and signaled a trend reversal.
Head and shoulders pattern is one of the solid bitcoin trading strategies. It is extensively used by traders to place a stop loss or long call. However, a lot has to happen for a complete formation of head and shoulders candlestick pattern, which is why this pattern hardly occurs in forex or Crypto markets. Recognizing the pattern and basing your Bitcoin trading strategies on it is useful, but a trader should also use other indicators and wait for confirmation before placing any call. Anyway, there is another bullish indicator, namely morning star pattern which occurs more often.