See the video of the Head and Shoulders pattern checklist, as exemplified on Tesla stock:
The head and shoulders pattern is one of the most famous chart patternsin technical analysis. It signals a bearish reversal after an uptrend, and it gives a clear structure for a trading opportunity. As the name suggests, the pattern looks like a head with two shoulders and one should keep in mind that the H&S, as it also called, in real life may vary from the text book chart pattern examples.
The first peak is the left shoulder, and it develops as investors lose interest in the asset starting to offload long positions. The second peak is the head and it’s higher than the left shoulder because some investors buy the left shoulder dip and as the price rises and rises the excitement leads to a higher peak before reversing back down as the move can’t be sustained and investors take off even more profits. The last peak is the right shoulder and that’s generally when late buyers can’t lift the price too much resulting in a lower peak than the head.
The line that connects all the troughs is called “neckline” and when the price breaks out of it, the pattern is said to be confirmed. How far the price can fall after the breakout is unpredictable, but traders generally target the measured move from the peak of the head to the neckline and project it to the downside.
Here’s an important checklist to increase your chances of identifying a reliable head and shoulders pattern:
- Is the timeframe high enough? (Ideally, weekly or higher)
- Is it after a clear uptrend?
- Is the Head and Shoulders neckline clear and is the price reacting to it?
- Is the volume of the left shoulder higher than the volume of the head (nice to have but not a must)
- Is there a clear breakout down from the neckline (pattern confirmed!)
VERIFY THESE POINTS NEXT TIME YOU SEE A HEAD & SHOULDERS CHART PATTERN:
1. IS THE TIMEFRAME HIGH ENOUGH?
The first thing you need to know is that patterns are not always perfect like the textbook examples because as the pattern forms you will see more up and down movements than just the straight lines you see on books or courses. As you get familiar with the pattern formation though you will build a natural recognition skill that will help you with your technical analysis .
Another critical thing you need to remember is that the head and shoulders pattern works best on higher timeframes like daily, weekly or higher. If you trade them on lower timeframes like 4 hour, 1 hour or even 15 minutes, you will notice that they are less reliable and prone to false moves as the noise on lower timeframes is much higher.
2. IS IT AFTER A CLEAR UPTREND?
For the best results you want to see the pattern forming after a clear uptrend as it’s a major reversal pattern by nature. You will see the pattern forming also in the middle of a bearish trend, which can help you timing the next leg lower, but the risks of it failing become higher so you need to be careful when you trade it as a continuation pattern.
3. IS THE HEAD AND SHOULDERS NECKLINE CLEAR AND IS THE PRICE REACTING TO IT?
When you connect the troughs of the head and shoulders pattern, you will want to see a clear neckline with the price reacting to it after the breakout. This happens because generally after a breakout the price pulls back to retest the neckline and it strengthens the case of a successful pattern if the price gets rejected after the retest.
4. IS THE VOLUME OF THE LEFT SHOULDER HIGHER THAN THE VOLUME OF THE HEAD?
Since this pattern is a reversal pattern, it should signal a loss in momentum to the upside. This weakening momentum can be seen by looking at the volume. You want to see the volume getting lower and lower as the price rallies after the left shoulder and the head of the pattern is being formed. This will be an extra confirmation that the upside move is based on shaky foundations.
5. IS THERE A CLEAR BREAKOUT DOWN FROM THE NECKLINE?
For an even higher chance of a reliable pattern, you want to see a clear breakout down from the neckline. You should see a firm break with the price not stalling nor ranging on the neckline, but just falling down through the neckline. This will tell you that the selling pressure is indeed very high and there’s not much buying interest.
This is a handy checklist that you can save or bookmark on your browser so that you can come back here and see if the pattern you are about to trade has a high chance of succeeding. If you are the type of person that prefers to watch our Head and Shoulders Pattern Checklist video rather than reading an article, then you can see the video below which includes bonus features for more tips and tricks on the head and shoulder pattern and leave a like so it gets saved to your favourite YouTube videos collection for easier search.
You are also invited to visit TradingView's technical analysis ideas for the Head and Shoulders stock pattern.
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