Introduction
If you’re a trader, you’ve probably heard of the head and shoulders trade. It’s a popular technical analysis pattern used by traders to identify potential reversals in the market. In this article, we’ll take an in-depth look at what the head and shoulders trade is, how to identify it, and how to use it in your trading strategy.
What is the Head and Shoulders Trade?
The head and shoulders trade is a bearish reversal pattern that occurs after an uptrend. It’s called the head and shoulders because the pattern looks like a head with two shoulders on either side. The left shoulder is formed when the price reaches a high and then retraces. The head is formed when the price reaches a higher high than the left shoulder and then retraces. The right shoulder is formed when the price reaches a lower high than the head and then retraces.
Identifying the Head and Shoulders Trade
To identify the head and shoulders trade, you need to look for three things: the left shoulder, the head, and the right shoulder. The left shoulder and the head should be roughly the same height, and the right shoulder should be lower than the head. The neckline is drawn by connecting the low points of the left and right shoulders.
Left Shoulder
The left shoulder is formed when the price reaches a high and then retraces. It should be roughly the same height as the head. This is the first sign of a potential head and shoulders trade.
Head
The head is formed when the price reaches a higher high than the left shoulder and then retraces. It should be the highest point of the pattern. This is the second sign of a potential head and shoulders trade.
Right Shoulder
The right shoulder is formed when the price reaches a lower high than the head and then retraces. It should be lower than the head and roughly the same height as the left shoulder. This is the final sign of a potential head and shoulders trade.
Using the Head and Shoulders Trade in Your Trading Strategy
Once you’ve identified a head and shoulders pattern, you can use it in your trading strategy. The neckline is an important level to watch. If the price breaks below the neckline, it’s a sign that the pattern has been confirmed, and the price is likely to continue lower.
Entry
To enter a head and shoulders trade, you can wait for the price to break below the neckline. This is a signal to enter a short position.
Stop Loss
To protect your capital, you should always use a stop loss when trading. In a head and shoulders trade, you can place your stop loss above the right shoulder.
Take Profit
To take profits, you can use a target that’s equal to the height of the pattern. For example, if the distance from the head to the neckline is 100 pips, you can set your take profit at 100 pips below the neckline.
Conclusion
The head and shoulders trade is a popular technical analysis pattern used by traders to identify potential reversals in the market. It’s important to remember that no trading strategy is foolproof, and you should always use proper risk management techniques. With that said, the head and shoulders trade can be a powerful tool in your trading arsenal when used correctly.
