Head and Shoulders Pattern
"Head and Shoulders" patterns are reversal formations that usually form at the market tops. "Head and Shoulders" patterns are very reliable, but failures do occur. When Head and Shoulders patterns fail, they reverse the pattern and trade in an explosive manner. Most "Head and Shoulders" patterns can be detected using volume patterns. During the left shoulder and the beginning of the "Head" formations, the volume will be heavy. While forming, volume dissipates on the right shoulder, and the volume increases during the breakdown.
A trend line or neckline is drawn connecting the "Head and Shoulders" pattern to determine the potential trade opportunities and targets. The neckline can be also formed in an angle (slanted).
Trade:
Connect "Head and Shoulders" bottoms in a trend line or neckline. When the price closes below the neckline, a potential short trade is signaled. Short one tick below the breakdown bar's low.
Target:
Compute the vertical distance between the "apex" of the "Head and Shoulders" pattern and the neckline. The target is set below this distance from the neckline.
Stop:
After a trade entry, if the price closes above the neckline, a potential failure of the pattern is signaled. Place a "stop" order above the neckline.
