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The Head and Shoulders

 

In the past articles we have treated and seen how patterns are formed on a chart of any financial instrument capable of offering valuable indications during our analyzes aimed at finding favorable situations for market entries. I would now like to continue our journey by bringing to your attention the most well-known GRAPHIC FORMATIONS of the price, the PRICE patterns, or series of candles that form real FIGURES on the chart that once emerged and well contextualized can trigger a SETUP for a any TRADE with high probability of success.

As always, and I will never get tired of repeating it, the simple observation and identification of a graphic formation is not enough; it is necessary every time to use the right mix of tools aimed at evaluating the whole well, therefore the volumes, the momentum, any moving averages or any indicator we prefer, but which helps us to contextualize and filter the signal in the best possible way, making so our eventual TRADE as reliable as possible.

In technical analysis there are many graphic formations, many with even strange names such as dead cat bounce (the famous bounce of the dead cat), or the cup with handle, the bullish flag, the various triangles or rectangles, or the famous head and shoulders.

 

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Nobody even forbids us to invent our own! The important thing, however, is that these graphical formations have been observed in the past by many analysts and have often given rise to quite marked changes in the price of any financial instrument. So it all takes its cue from the definition, or rather from the idea, cited several times in technical analysis texts, that history repeats itself, therefore also the graphic formations and with them the price trend.

One of the advantages that the use of graphic formations gives to our operations is that we are going to trade on the price, that is, on what is really happening on the chart and not, as for example happens with the indicators, with something that has not yet happened. or worse still it is already in the phase of attenuation because as we have said in past articles on oscillators or moving averages, they are often lagging behind.

Normally all graphic formations, or rather the vast majority of them, are classified as continuation formations and inversion formations. Technical analysis experts and scholars have claimed that there are more than 50 graphic formations and that some are made up of even over thirty candles or formation bars! I personally believe that some of them are really difficult both to find and to objectify and they leave some time they find. Knowing the main beliefs can really help in your operations allowing you to obtain good results.

So from this article and for the next I will want to deal with those that I consider simpler and more intuitive and above all easy to objectify. It should also be said, to be fair, that it will not always be easy to see them clearly on real graphs as perhaps they are represented in textbooks, with the maximums and minimums always clearly visible and equidistant, sometimes to better see a graphic formation it will even be useful to change the TIME FRAME to eliminate the “noises of the market” that maybe dirty the graphics on too low periods. So let’s start today with the first graphic training, perhaps the most used and abused and discussed: THE HEAD SHOULDER MODEL.

 

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To be defined and classified as such, a head and shoulders formation must consist of four points fundamental (obviously we are referring to a bearish head and shoulders which will then find itself during a clear upward trend and will predict a possible reversal).

First point: left shoulder

This shoulder represents the relative maximum, or higher maximum, during the push phase of the uptrend. At some point the trend will have a moment of strong retracement thus forming a fairly evident low that maybe will lean on an important support level.

Second point: the head.

The market will then resume its climb respecting the UP trend and will go over the previous maximum, it will form a peak which in many cases is the final push of the current trend. The price at this point will initiate a further sharp downward correction and will most likely mark a new low near the level touched by the previous retracement.

Third point: right shoulder

At this point, buyers seem to be able to get the better of them again and prices start to rise again forming a relative maximum that will be more or less on the same level as that marked by the left shoulder. Meanwhile, volumes during this phase will probably be in sharp decline, a sign that buyers are losing vigor and the price therefore begins to descend again towards the minimum levels touched previously.

Fourth point: neck line

The neck line is nothing more than a support line which is tested by the first shoulder and then by the head and finally by the right shoulder. It is therefore an excellent price level, excellent support. At this point the head and shoulders formation seems ready to be traded … but obviously the price does not go up again to form another relative maximum, which if it is not higher than the previous absolute maximum will not invalidate our graphic formation, vice versa if it were to continue its ascent, the trend would regain vigor and we will still expect some rises for the following periods. Usually in these cases the volumes start to rise and the momentum grows conspicuously therefore the previous phase will not have been of inversion but rather of CONSOLIDATION with laterality.

 

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If, on the other hand, prices will fall and go to cut, to break the support of the NECK LINE, then our head and shoulders will have been completed and we can consequently expect a clear reversal of the trend. The more prudent and conservative traders will wait, before their short entry into the market, for further confirmation and that is the retest of the neck line from bottom to top which this time will have to reject the price thus acting as a resistance. Usually the stop loss for this type of entry will be placed a few pips above the right shoulder and the TP will be placed at a distance equal to the number of pips between the top of the head and the neck line. For today we have concluded our article, but stay connected with our BLOG because with the next releases we will analyze other very interesting and useful graphic formations to try to better face the financial markets!

 

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