Page 10 - Module & Head and Shoulders

Module 7 – Head and Shoulders

security at a poor time will be forced to exit their positions, thus creating a reversal of similar
magnitude to the topping pattern which just occurred.

The neckline is the point at which many traders are experiencing pain and will be forced to exit
positions, thus pushing the price towards the price target.

Volume can be watched as well. During inverse head and shoulder patterns (market bottoms), we
would ideally like the volume to expand as a breakout occurs. This shows increased buying interest
that will move price towards the target. Decreasing volume shows lack of interest in the upside move
and warrants some scepticism.

6. the pitfalls of trading head and shoulders

As stated, the pattern is not perfect. Here are some potential problems with trading a head and
shoulders pattern:

▪ You need to find patterns and watch them develop, but you should not trade this strategy until
it is completed. So, it could mean a long period of waiting. It will not work all the time. The stop
levels will be hit sometimes.
▪ The profit target will not always be reached, so traders may wish to fine tune how market
variables will affect their exit from the security.
▪ The pattern is not always tradable. For example, if there is a massive drop on one of the
shoulders due to an unpredictable event, then the calculated price targets will likely not be hit.
▪ Patterns can be subjective. One trader may see a shoulder, where another does not. When
trading patterns, define what constitutes a pattern for you beforehand - given the general
guidelines above.

7. head and shoulders pro tips

Trade Tip #1
Pattern must form after an extended move higher
It can only be a bearish reversal pattern if it forms after an extended move higher. One way to check
is to make sure there are no immediate swing highs to the left of the formation. Take a look at the
chart below. Do you notice all the “white space” to the left? This is what you want to see when trading
any bearish reversal pattern.

Trade Tip #2
Neither shoulders should be above the head
Can you raise your shoulders above your head? The same applies to this technical pattern/ The head
should always stick out above both the left and right shoulders. While there’s no exact rule for the
distance, it should be evident from a quick glance.

Trade Tip #3
Stick to daily and weekly time frames
Irrespective of trading these reversals on 1h and 4 h timeframe, you run the risk of finding a lot of
false positives. That is a pattern that looks like a head and shoulders but doesn’t perform like one.
To avoid this be sure to stick to the daily time frame and higher.
Trade Tip #4
The neckline should be horizontal orascending
If you find a head and shoulders where the neckline moves from the top left to the bottom right, stay
on the sideline.

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