What is Head and Shoulders Pattern? How does Head and Shoulders Pattern Work? And Reliability of Head and Shoulders Pattern
What is Head and Shoulders Pattern?
The Head and Shoulders pattern is a technical chart pattern used by traders to identify potential trend reversals in financial markets. It is a pattern that resembles a head with two shoulders on either side.
The pattern is formed by three peaks, with the middle peak being the highest and the two outer peaks being lower and roughly equal in height. The outer peaks are referred to as the “shoulders,” while the middle peak is called the “head.” The pattern is considered complete when the price breaks below a “neckline” that connects the two low points of the two shoulders.
The Head and Shoulders pattern is widely used in technical analysis, and traders often look for it to identify a potential trend reversal from an uptrend to a downtrend. The pattern is considered a reliable indicator of a potential trend reversal when it is confirmed by high trading volumes and other technical indicators.
How does Head and Shoulders Pattern Work?
When this pattern appears on a price chart, it suggests that the market is losing its upward momentum and may start to move in a downtrend direction.
Here’s how head and shoulder pattern work:
- The left shoulder: The pattern starts with an upward trend in price. The left shoulder is formed when the price reaches a high point and then pulls back to form a low point.
- The head: The price then rises again to reach a higher high than the left shoulder. This is the head of the pattern.
- The right shoulder: After the head, the price retraces back to form another low point, which is roughly the same level as the low point of the left shoulder. This forms the right shoulder of the pattern.
- The neckline: The neckline is a line that connects the two lows of the left and right shoulders. It is a key level to watch because if the price falls below the neckline, it is a signal that the pattern is complete and that the market is likely to enter a downtrend.
- Confirmation: To confirm the pattern, traders look for high trading volumes and other technical indicators such as moving averages, momentum oscillators, and trendlines to support the potential trend reversal.
Reliability of Head and Shoulders Pattern:
The reliability of the Head and Shoulders pattern in predicting trend reversals depends on several factors, including the market conditions, the timeframe being analysed, and the strength of the pattern itself.
In general, the Head and Shoulders pattern is considered a reliable pattern for identifying potential trend reversals in financial markets. However, it is important to note that no technical analysis tool or pattern is 100% accurate, and there is always a risk of false signals.
To increase the reliability of the Head and Shoulders pattern, traders should look for additional confirmations such as high trading volumes, a break of the neckline, and other technical indicators that support the potential trend reversal.
Additionally, traders should also be aware of market conditions that could affect the pattern’s reliability. For example, if the market is experiencing high volatility or if there is significant news or events that could impact the market, the reliability of the pattern may be lower.
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