The head and shoulders pattern is a type of chart structure that forms three peaks when the outer ratios of the two peaks are close together, and the middle peak becomes the highest peak. In technical analysis, the head and shoulders pattern represents a specific type of chart structure in which a bullish trend transforms into a bearish trend.
The head and shoulders pattern is one of the most trusted reversal patterns. If we want to name patterns with high certainty in technical analysis, this is the best case showing that a positive trend is ending.
What is Head and Shoulders Pattern
The head and shoulders pattern forms when the value of a cryptocurrency asset rises to a peak then returns to normal. Then goes above the first peak and returns to the original price. Eventually, the asset price will rise again but only reach the size of the first peak, then fall again and return to the pattern bottleneck in the chart. In the same way, a head and shoulders pattern is completed and shows a positive trend that has been completed.
Head and Shoulders pattern indicators
The head and shoulders template includes features that display the price of an asset as follows:
- After a long-term positive trend, the price moves towards the peak and then returns to build a trough.
- The price rises again, making the second peak higher than the first and falling again.
- The price rises for the third time but only increases as much as the first peak, then returns.
The first and third peaks are the shoulders, and the second peak represents the Head. The line that connects the first and second troughs is called the throat.
The inverse or reverse head and shoulders pattern is another reliable indicator and shows a negative trend that turns into a positive trend. In this case, the asset price reaches three minimum points in a row and rises. The second trough is the Head, and the first and third are the shoulders. The last move after the third decline is a bearish trend where prices suddenly start to rise.
The price of digital assets is the result of a tug-of-war game. Whether the cost of an asset goes up or down is a direct result of how people behave. Those who believe that asset prices are rising are called bulls, and those who think prices are falling are called Bears. If most cryptocurrency shareholders are bears, the price goes down to the point where the stock is sold enough to make up for lost money. If most shareholders are bullish, the price goes up, and new investors buy to get better positions.
Inverse Head and Shoulders
There is also a chart opposite the Head and shoulders called the inverse Head and shoulders. This chart is precisely intended to predict the return of negative trends. The pattern forms when an asset price action encounters these characteristics: the price goes down a trough and rises. The price comes down again from the previous trough and rises again. Eventually, the price falls again but goes down as much as the first decrease and then goes up. The price goes up until it reaches the resistance line near the troughs.
Pattern formation story
Like other chart patterns, the top and bottom of the head and shoulders pattern tell a specific story of the Bulls and Bears competition.
The first peak and the second decrease indicate the downward movement of the previous uptrend. They keep moving as positively as possible, and the Bulls raise the price to the first peak to reach the second peak, Head. At this point, the Bulls may still take over the market and continue the positive trend (so the pattern is not formed)
However, if the price falls for the second time and rises again to a point precisely the size of the first peak, it is clear that the bears have taken over the market. The bulls are trying to raise the price again but only as much as the first peak. This failure causes the bears to surround the market and lower the price as much as possible. In this case, the pattern is completely formed.
How to recognize this pattern?
The pattern includes the left shoulder, head, and right shoulder, which shows a baseline with three peaks if the middle peak is higher than the first and third peaks. The left shoulder decreases in price, followed by lower The subsequent increase is marked. Head forms when the price includes a more prominent peak and returns. The right shoulder is also made by increasing the price by the size of the left shoulder and then decreasing it. With this procedure, the head and shoulders pattern will be formed.
What Does a Head and Shoulders Pattern Indicate?
The pattern is an indicator to show where the current trend will go. A bullish trend changes to bearish in the original head and shoulders pattern in the actual head and shoulders pattern. If the reversal is considered, a bearish pattern changes to bullish. This pattern is one of the most reliable processes for identifying market routines.
How to Trade the Pattern?
To trade according to the Head and shoulders pattern, there are some things that you should pay attention to. The Neckline indicates the level of resistance or support that traders should mark as strategic areas. The first step is to find the left shoulder, head, and right shoulder on the chart to position the Neckline. In a standard Head and Shoulders pattern, we need to connect the low after the left shoulder to the low after the Head. This line forms the Neckline. We also explain the importance of the Neckline. In an Inverse Head and Shoulders pattern, we have to connect the high after the left shoulder to the High after the Head to form the Neckline.
To trade on this template, you must wait for it to be fully formed. This is because if the pattern is not fully developed, it can cause many losses to traders. Incomplete or incomplete patterns should also be analyzed, but you should never start trading until the neckline pattern breaks.
We should look for the price action to reach below the peak neckline after the right shoulder in the head and shoulders pattern. For the inverse head and shoulders chart, we have to wait for the price to reach higher than the Neckline after the right shoulder.
The transaction can be done by completing the template. Specify the entry point first, then the stops, and then the profit targets, and consider what variables can change your profit target.
The most likely entry point is when a breakout occurs, the Neckline is broken, and the transaction occurs. Another issue is to wait longer to start the trade, and the absolute position may be lost. This method involves waiting for the pullbacks to the Neckline after the breakout. This is more conservative because we can see that if the retreat stops and resumes in the initial direction of failure if the price continues in the order of loss, the trade may be lost.
The stops are placed just above the right shoulder when the Neckline injects in a traditional market. The head pattern can be considered a stop in the other method, but this hazardous method reduces the test and the amount of reward relative to the risk. The stop point should be below the right shoulder in an inverse pattern. Again, the stop can be placed on the template head. However, there is a lot of risks involved in making a deal.
Setting Your Profit Targets
Finally, you need to set a profit target for the model. This goal is the price difference between the Head and the low of each shoulder. This difference is then deducted from the neckline breakout level to determine the price target on the downside. The difference must be added to the neckline breakout price for the inverse pattern to determine the target price.
Head and shoulders and Inverse head and shoulders patterns are chart patterns used in technical analysis to detect reversal trends. Both patterns are among the most reliable analyzes you can use to predict the price of an asset in cryptocurrencies. However, you should keep in mind that there are also breakpoints that you have to prevent with previous predictions in any technical analysis.