How Trade Head Shoulder in Forex.

A breakdown of how to trade the head and shoulders pattern in forex:

Identifying the Pattern:

1. Trend: Look for the head and shoulders pattern to form after a preceding uptrend. This signals a potential reversal.

1. Left Shoulder: The pattern starts with a price rise followed by a peak (left shoulder) and then a decline.
2. Head: The price rises again, forming a higher peak (head) than the left shoulder.
3. Right Shoulder: The price falls again, followed by another rise that forms a right shoulder. This peak should be lower than the head.

1. Neckline: Draw a horizontal line connecting the lows of the troughs between the left and right shoulders. This is the neckline. A downward sloping neckline can strengthen the bearish signal.

Taking a Trade:

• Entry: The most common entry point is a breakout below the neckline after the right shoulder forms. This signifies a potential price decline. You would initiate a sell trade.

• Stop Loss: Place a stop-loss order above the neckline, typically a few pips above the highest point. This limits potential losses if the price action doesn't follow the pattern.

• Target: A common method to set a target price is to measure the vertical distance between the head and the neckline. Then add that distance to the neckline breakout point. This gives you an estimated price where the downtrend could end.

Cautions and Considerations:

• False Signals: Head and shoulders patterns don't guarantee a price decline. The price may rise through the neckline, invalidating the pattern (called a failed breakout). Be prepared to exit the trade if this happens.

• Confirmation: Look for additional confirmation signals like bearish moving average crossovers or increased selling volume to strengthen the trade idea.

• Risk Management: Always practice proper risk management. Only invest a small portion of your capital per trade and adhere to your stop-loss orders.
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Why the Head and Shoulders Pattern Works

No pattern is perfect, nor does it work every time. Yet there are several reasons why the chart pattern theoretically works (the market top will be used for this reasoning, but it applies to both):

• As price falls from the market high (head), sellers have begun to enter the market and there is less aggressive buying.
• As the neckline is approached, many people who bought in the final wave higher or bought on the rally in the right shoulder are now proven wrong and facing large losses—it is this large group that will now exit positions, driving the price toward the profit target.
• The stop above the right shoulder is logical because the trend has shifted downwards—the right shoulder is a lower high than the head—and therefore the right shoulder is unlikely to be broken until an uptrend resumes.
• The profit target assumes that those who are wrong or purchased the security at a poor time will be forced to exit their positions, thus creating a reversal of similar magnitude to the topping pattern that 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 toward the price target.
• Volume can be watched as well. During inverse head and shoulders patterns (market bottoms), we would ideally like the volume to expand as a breakout occurs. This shows increased buying interest that will move the price towards the target. Decreasing volume shows a lack of interest in the upside move and warrants some skepticism.

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 the pattern 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.

Remember: Forex trading involves inherent risks. This is a simplified overview, and further research and practice are recommended before risking capital.