When it comes to classic price chart patterns, you really can’t get more classic than the Head and Shoulders pattern. This pattern is so famous, it’s practically a rockstar of technical analysis. In fact, if there were a Hall of Fame for chart patterns, the Head and Shoulders would be inducted as the “Mother of All Patterns” (yes, it’s that legendary).
But what exactly is this iconic pattern?
In this post, we’ll dive into the nitty-gritty of the Head and Shoulders pattern. Buckle up, because you’re about to learn everything you need to know: from the anatomy of this reversal pattern, to the psychology behind it, and, of course, how to trade it.
Table of Contents
Head & Shoulders Anatomy
So, let’s talk about the obvious. The Head and Shoulders pattern is made up of… wait for it… a head, two shoulders, and—drumroll, please—ends with a critical neckline. I know, groundbreaking stuff. You can see an example of the bearish reversal Head and Shoulders pattern in the provided image.
Now, aside from the obvious parts—like the head, shoulders, and neckline—there are also three key support and resistance levels you need to keep an eye on. First, there’s the support at the neckline, which is crucial. Then, there’s the first resistance at the peak of the left shoulder. And finally, a stronger second resistance at the price level of the head’s peak.
Just as every villain has a hero, every reversal pattern has its counterpart. Enter the Inverted Head and Shoulders pattern, which is basically the bullish version of the classic pattern. It’s not anything too complex—just horizontally mirror everything you saw in the normal Head and Shoulders. Same concept, but this time it signals a bullish reversal instead of a bearish one.
Check out the example in the image below.
Now that we’ve covered the basics of the anatomy, here’s the important bit: The pattern is not considered valid unless we see a significant breakout below the neckline support level after the formation of the right shoulder.
And, here’s the kicker: If that breakout is accompanied by high trading volume, then a bearish reversal is highly likely. But enough with the anatomy. What’s the story behind the creation of this pattern? Don’t worry, we’ll cover that next!
How Does a Head & Shoulders Reversal Work?
Since the Head and Shoulders pattern is a reversal pattern, you’ll typically find it at the peak of a strong upward trend. The market has been making higher highs and higher lows in this bullish trend, but eventually, something changes. The market fails to create a higher low, and this marks the formation of the second trough in the Head and Shoulders pattern. This is the point where the neckline starts to form.
Now, the market bulls—who have been riding this trend—try to push the price to a new high. But guess what? The first resistance level at the peak of the left shoulder is just too strong for them to break. Even worse, they’re nowhere near breaking through the second, more powerful resistance at the peak of the head. At this point, the bulls start to lose hope. They’ve tried, but the market just won’t budge.
And here’s the kicker: Since the Head and Shoulders pattern is so widely recognized (I mean, it’s basically the celebrity of chart patterns), its formation becomes a bit of a self-fulfilling prophecy. Once traders see it taking shape, many jump to conclusions and start selling. The pattern is so well-known that everyone starts acting on it, reinforcing its likelihood.
As the market continues to fail at pushing higher, it becomes increasingly obvious that a reversal is imminent. Now, the bears—who’ve been waiting for this moment—rush in. The price finally breaks below the neckline support level, and with that, the pattern is complete. The breakout triggers a shift in sentiment, and the market starts reversing the trend, just as the Head and Shoulders pattern predicted.
Just like its bearish counterpart, the bullish Inverted Head and Shoulders pattern tells a story of reversal, but this time it forms at the tail end of a fading downtrend. In a downtrend, the market has been making lower lows and lower highs—until it reaches a point where it fails to create a lower high. This marks the formation of the second peak, just before the right shoulder, and sets the stage for the neckline.
Now, instead of the bulls struggling to push prices higher, the bears try to continue the downtrend by pushing for another lower low. However, the first support level at the right shoulder peak proves too much for them to break, let alone the stronger support at the head’s low point. This is where the bulls start to get a glimmer of hope.
Just as the Head and Shoulders pattern is a widely recognized bearish signal, the Inverted Head and Shoulders is equally famous as a bullish one. As traders spot this formation, it becomes a self-fulfilling prophecy in the opposite direction. As the pattern takes shape and the breakout becomes more obvious, more and more traders begin buying in.
Once the price breaks above the neckline, the bulls take full control. The breakout completes the pattern and signals the reversal of the downtrend into an uptrend.
You can see an example of the Inverted Head and Shoulders pattern in the image below.
Trading Head and Shoulders Pattern
Now, let’s get to the fun part—the sweet spot of trading the Head and Shoulders pattern. To make things easier to digest, we’ll break it down into four scenarios:
- Valid Head and Shoulders
- Valid Inverted Head and Shoulders
- Failed Head and Shoulders
- Failed Inverted Head and Shoulders
A common rule of thumb? If a pattern fails, it usually ends up having the opposite effect on price compared to its valid counterpart.
Trading a Valid Head and Shoulders
In a valid Head and Shoulders pattern, the key to confirming it is volume. Ideally, the volume should drop during the formation of the right shoulder. As the price breaks below the neckline support, however, the volume should increase significantly, confirming that the pattern is valid and strong.
Once the price breaks below the neckline with high volume and momentum, the pattern is verified, and a downward reversal is likely.
At this point, you can open a short position. Now, when it comes to opening a short position, you’ve got two options:
- Option 1: Wait for the “Last Kiss” – This is the safer bet. After the neckline breaks, you wait for a retracement to retest the broken neckline as resistance. If the price fails to break back above the neckline, you can confidently enter a short position.
- Option 2: Enter Immediately After the Neckline Breaks – This is a more aggressive approach. You open the short position as soon as the neckline fails. However, keep in mind that this increases your risk of falling for a bear trap if the pattern isn’t strong enough, or if the breakout turns out to be a false signal.
For your take profit, a common method is to measure the pattern’s width (the distance from the head’s peak to the neckline) and project that distance downward from the neckline. This gives you a reasonable target for how far the price could drop.
As for your stop loss, there are several approaches. Choose what fits your risk tolerance best. The standard approach is to set the stop loss just above the shoulders, but for a better reward-to-risk ratio, you might want to set a tighter stop loss—say, halfway up the pattern or even just above the neckline. This minimizes risk while keeping your trade active.
Trading a Valid Inverted Head and Shoulders
When it comes to the Inverted Head and Shoulders, the bullish counterpart to the last scenario, almost all of the same principles apply—but in reverse. So, just like the previous section, You should look for volume patterns and a valid breakout to confirm the reversal.
Just as with the Head and Shoulders, the volume should ideally decrease as the right shoulder forms. However, as the price breaks above the neckline resistance, you want to see an increase in volume. This signals that the pattern is valid and the bullish reversal is likely.
Once the price breaks above the neckline with sufficient volume and momentum, you can expect a reversal to the upside. As to when to open a long position, you have the same two options, either enter a long asap or wait for a last kiss.
For your take profit, you can apply the same method as before: Measure the width of the pattern (the distance between the head’s low point and the neckline) and project that distance upwards from the neckline to determine your target price.
As for your stop loss, you can place it below the lowest point of the right shoulder or just below the neckline, depending on your risk tolerance.
Trading a Failed Head and Shoulders
To effectively trade this setup, it’s essential to first understand what a “Failed Pattern” means. A failed pattern occurs when a Head and Shoulders pattern does not play out as expected. Instead of reversal, the price continues in the original trend direction, invalidating the initial signal.
In the case of a Head and Shoulders pattern, failure is confirmed when the price moves above the shoulder level after the formation of the right shoulder. This can happen with or without a bear trap at the neckline (You can see a bear trap in the sample Image). When the pattern fails, it indicates that the bearish reversal signal is no longer valid, and the price is likely to resume its uptrend.
Once the Head and Shoulders pattern fails, traders can look for opportunities to enter a long position. A key entry point occurs when the price passes the head’s peak and breaks through the second resistance level. Alternatively, you can wait for a retest of the broken resistance on head price level, which now acts as a support level, to confirm the strength of the uptrend.
For risk management, the recommended stop loss is placed just below the shoulder level. You also can place it below the head level to ensure minimal loss if the trade goes against you. The take profit target is calculated by adding the pattern’s width (the distance from the head to the neckline) to the breakout price. Refer to the provided example image for a visual representation of this setup.
Trading a Failed Inverted Head and Shoulders
Alright, if you’ve been following along with focus and dedication (which I know you have!), you can probably guess what’s coming in this section. Yes, that’s right! The Inverted Head and Shoulders pattern fails in the same way—but in reverse.
A failed Inverted Head and Shoulders pattern occurs when the price moves below the shoulder level after the formation of the right shoulder. Similar to the failed Head and Shoulders pattern, this can happen in two ways: with or without a Bull Trap.
When the Inverted Head and Shoulders pattern fails, expect the price to fall back to the downtrend. After the price breaks below the head’s support level, you can open a short position. Alternatively, you can wait for a “Last Kiss” pattern, where the price retests the broken support (now acting as resistance). If the price fails to break back above, this becomes your signal to go short.
As for Stop Loss, the standard stop loss placement is just above the shoulder level to protect you in case the price decides to push higher. However, if you want to go for a tighter stop loss, you can place it just above the head price level, depending on your risk tolerance.
Final Words
Congratulations! If you’ve made it this far, you’re already among the top 10% of people who truly value quality information and don’t just skim through complex topics like trading. This dedication is what sets apart the successful traders from the rest.
In this post, you’ve learned about the anatomy of the Head and Shoulders pattern, from its basic components—the head, the shoulders, and the crucial neckline—to the story behind it. You now understand how the pattern forms at the top of an uptrend, where the bulls lose momentum, and how the market shifts to a bearish phase as a result. We’ve also discussed how to spot this pattern in both its valid and failed forms, and the strategies for trading them. You now know when to enter a trade, where to place your stop loss, and how to determine your take profit.
However, we didn’t cover every existing scenario as you are. There’s one critical aspect of failing patterns: sometimes, the failure happens so gradually that the trade opportunity fades away as the price enters a range market and consolidation phase. At that point, the future trajectory becomes uncertain due to market action and fundamentals, making it impossible to predict the next move. I highly recommend steering clear of failed patterns that lead to a range-bound market. Instead, focus on training your eye to recognize the four key trading scenarios we’ve covered.
Happy Trading!
FAQ
The Head and Shoulders is a classic chart pattern signaling a trend reversal. It consists of three peaks: a higher peak (head) between two lower peaks (shoulders), and a neckline that acts as critical support.
Look for three peaks: a higher peak (head) between two lower peaks (shoulders). The pattern is confirmed when the price breaks below the neckline, signaling a
potential bearish reversal.
A pattern fails when the price moves above the shoulder level after the right shoulder forms, invalidating the bearish signal. This could happen with or without a bear trap at the neckline.
In a valid Inverted Head and Shoulders, after breaking the neckline upwards, open a long position. Place a stop loss below the right shoulder and take profit based on the pattern’s width.
When a Head and Shoulders fails, the price typically returns to an uptrend. If it breaks above the head peak and second resistance, consider entering a long position or wait for a retest of the broken resistance.
