Introduction:
As an investor, it is essential to be familiar with the different chart patterns that can help you make informed decisions. One such pattern is the head and shoulders pattern, which is widely used by traders to predict market trends. However, even the most reliable chart patterns can fail, and it is essential to understand why.
What is the Head and Shoulders Pattern?
The head and shoulders pattern is a technical analysis charting pattern that is used to identify a potential reversal in the market trend. It is characterized by three peaks, with the middle peak being the highest, and the two outer peaks being lower in height. The pattern is named after its resemblance to a head and two shoulders.
How to Identify the Head and Shoulders Pattern?
To identify the head and shoulders pattern, traders look for three peaks on a chart, with the middle peak being the highest. The two outer peaks should be of similar height, and the pattern should be accompanied by a neckline. The neckline is usually drawn by connecting the low points between the peaks.
Why Does the Head and Shoulders Pattern Fail?
The head and shoulders pattern is a reliable chart pattern, but it can fail due to a few reasons. One of the most common reasons for failure is when the pattern is not fully formed. Traders need to wait for the third peak to form before confirming the pattern. If the third peak fails to form, the pattern is considered invalid.
Other Reasons for Failure:
Another reason for the failure of the head and shoulders pattern is when the price breaks above the neckline. The neckline is considered a significant support level, and a break above it indicates that the market trend may continue. Other factors that can cause the pattern to fail include low trading volume, market volatility, and unexpected news events.
What Happens When the Head and Shoulders Pattern Fails?
When the head and shoulders pattern fails, traders need to re-evaluate their trading strategy. They may need to adjust their stop-loss levels, take profit targets, or even exit the trade altogether. It is essential to remember that a failed pattern does not necessarily mean that the market trend will reverse.
How to Trade the Head and Shoulders Pattern?
Traders can trade the head and shoulders pattern by waiting for the pattern to fully form and then entering a short position when the price breaks below the neckline. The stop-loss level should be placed above the right shoulder, and the take profit level should be set at a distance equal to the height of the pattern, measured from the head to the neckline.
Conclusion:
The head and shoulders pattern is a reliable chart pattern that can help traders identify potential market reversals. However, even the most reliable patterns can fail, and it is essential to understand why. Traders need to be patient and wait for the pattern to fully form before entering a trade. They also need to be aware of the reasons why the pattern can fail and adjust their trading strategy accordingly.
