You’ve been taught when a Head and Shoulders pattern is formed, the market is about to reverse lower.
So, you short the market.
However, the market continues to move higher, and you get stopped out.
It sucks to lose especially when you’re doing something that’s “supposed” to work.
But as it turns out, there’s more than meets the eye.
That’s why I’ve written this trading strategy guide to help you trade the Head and Shoulders pattern profitably and avoid the most common mistakes traders make.
What is a Head and Shoulders pattern and how does it work?
The Head and Shoulders pattern is a reversal chart pattern.
It consists of four parts:
The left shoulder
The right shoulder
Here’s what I mean:
But what does it mean?
Let’s analyze it together…
Left Shoulder – The market does a pullback. At this point, there’s no way to tell if the market will reverse because a pullback occurs regularly in a trending market.
Head – The market trades above the previous high. However, the sellers took control and push the price lower towards the previous swing low (forming the Neckline).
Right Shoulder – The buyers make a final attempt to push the price higher, but it failed to even break above the previous high (the head). Then, the sellers take control and push the price towards the Neckline.
Neckline – This is the last line of defense for the buyers. If the price breaks below it, the market could head lower and begin the start of a downtrend.
The Head and Shoulders pattern signals a possible trend reversal as the buyers cannot push the price higher.
And the opposite of it is called The Inverse Head and Shoulders pattern — which signals a possible trend reversal as the sellers cannot push the price lower.
You’ll learn the biggest mistake traders make when trading the Head and Shoulders pattern — and how you can avoid it.
The 2 things you MUST know before you trade the Head and Shoulders chart pattern…
You might wonder:
“How reliable is the Head and Shoulders chart pattern?”
Well here’s the deal…
Not all Head and Shoulders patterns are created equal.
There are 2 things you must pay attention to:
The market structure
The duration of the pattern
1. The market structure
Yes, the Head and Shoulders is a reversal chart pattern.
But, if the market is in a strong uptrend, it’s unlikely that a simple chart pattern can reverse the entire move.
Instead, the market is likely to continue higher.
2. The duration of the pattern
Here’s the thing:
A Head and Shoulders that takes 200 days to form is MORE significant than a Head and Shoulders that takes 20 days to form.
Because if the market breaks the 200-day Neckline, more traders will get “trapped” and their rush for exit will increase the selling pressure.
Now, it doesn’t mean you go short immediately when the price breaks the Neckline (I’ll explain why later).
But for now, remember this…
If you want to find reliable or high probability Head and Shoulders trading setups, then you must pay attention to the market structure and duration of the pattern.
How to trade Head and Shoulders chart pattern: Breakout with Buildup
Most of you would spot a Head and Shoulders pattern and go short on the break of the Neckline.
And where do you put your stop loss?
Above the head.
Here’s what I mean…
Clearly, your stop loss is large and this results in a poor risk to reward.
The market must move A LOT just for you to make 1R on your trade.
So, is there a better way to trade the breakout?
And it’s trading breakout with buildup.
This means you’ll wait for the market to form a tight consolidation near the Neckline (or Support).
And if the market does break down, you can reference your stop loss just above the highs of the buildup.
Here’s an example:
You get a more favorable risk to reward compared to setting your stop loss above the high of the Head.
The First Pullback: How to catch a piece of the move after the breakdown
You might be wondering:
“But what if the market doesn’t form a buildup and still continues to head lower, won’t I miss the move?”
That’s a good question.
And that’s why I’m about to share with you a technique called, The First Pullback.
Here’s how it works…
If the market breaks down without forming a buildup, then wait for a pullback to occur
If the market does a pullback, then go short on the break of the swing lows
Set your stop loss above the highs of the pullback
An example: The First Pullback
The best pullbacks are those with “shallow” retracement and small-bodied candles.
But what if you get a steep pullback and large-bodied candles?
That’s what I’ll cover next…
The Re-test: How to short the market at a higher price
There are times the pullback is deeper than you expect.
But all is not lost because you can use The Re-test technique to time your entry and even short the market at better prices.
If the pullback is deep, then wait for the price to re-test the Neckline (or previous Support turned Resistance)
If the price re-tests the Neckline, then wait for a price rejection (like Shooting Star, Bearish Engulfing pattern, etc.)
If there’s a price rejection, then go short on the next candle
Set your stop loss 1 ATR above the swing high
Here’s what I mean: The Re-test
Moving on, you’ll learn how to short the Head and Shoulders pattern before the herd catches on…
Ahead of the crowd: How to short the Head and Shoulders pattern and make a profit even before it reaches the neckline
Do you know you can short the Head and Shoulders pattern before the Right Shoulder is formed?
This offers a favorable risk to reward on your trade — and you’re IN the money even before the Neckline is broken.
Want to know this little-known technique?
Wait for the market to form the Left Shoulder and Head
After it’s formed, let the price rally higher back towards the Head
Go short when you get a price rejection (like Shooting Star, Bearish Engulfing pattern, etc.)
Set your stop loss 1ATR above the swing high
Here’s an example: Ahead of the Crowd
Clearly, if the market drops lower, you’re positioned to ride the move down while other traders scramble to “chase” the market.
This one “trick” improves your odds when trading the Head and Shoulders chart pattern
Now let’s take things a step further.
If you want to find the highest probability Head and Shoulders trading setup, then you must use multiple timeframes.
Here’s what to look for…
The higher timeframe is in a downtrend
The Head and Shoulders pattern “lean against” Resistance on the higher timeframe
An example: Bitcoin coming into Resistance on a 4-hour timeframe…
Bitcoin forms a Head & Shoulders pattern on the 1-hour timeframe…
And then, you can use any of the 4 techniques I’ve shared earlier to time your entry.
How to exit your trade for maximum profits
You’re probably wondering:
“So how do I exit my winners?”
Well, here are 3 techniques you can use…
Trailing stop loss
Capture the swing
Let me explain…
1. How to trail your stop loss and ride big trends
If you’ve followed me for a while, you know I like to trail my stop loss to ride massive trends.
So, one way you can do it is to trail your stop loss with the 20-period moving average (MA).
This means you’ll only exit your trade if the market closes above the 20MA.
2. The Price Projection
This is a classical charting technique that determines where the move might end.
Here’s how it works…
Identify the length from the Head to the Neckline
“Copy and paste” the length from the Neckline downwards
3. Capture the swing
This is for The Re-test and Ahead of the Crowd technique.
The idea behind it is to capture one swing in the markets — and that’s it.
Identify the swing low where buying pressure is likely to step in
Exit your trade before the swing low
Here’s what I mean…
Now some of you might be wondering:
“So which is the best approach to exit your winners?”
Here’s the thing…
There’s no best approach.
Instead, you must know what your goals are and then apply the appropriate technique.
If you want to ride massive trends, then you’ll use a trailing stop loss.
If you want a higher win rate, then you can use Capture the swing.
Here’s what you’ve learned:
The Head and Shoulders pattern signals a possible trend reversal as the buyers cannot push the price higher
Not all Head and Shoulders patterns are created equal. You must pay attention to the market structure and the duration of the pattern
4 techniques to trade the Head and Shoulders chart pattern. This includes the Breakout with Buildup, The First Pullback, The Re-test, and Ahead of the Crowd
You can improve the odds of your trade when The Head and Shoulders pattern lean against Resistance on the higher timeframe
3 approaches to exit your trades: The trailing stop loss, The Price Projection and Capture the Swing
Now over to you…
How do you trade The Head and Shoulders pattern?
Leave a comment below and share your thoughts with me