head and shoulders chart pattern in technical analysis

What Is a Head and Shoulders Chart Pattern in Technical Analysis?

A head and shoulders pattern is used in technical analysis. It is a specific chart formation that predicts a bullish-to-bearish trend reversal. The pattern appears as a baseline with three peaks, where the outside two are close in height, and the middle is highest.The head and shoulders pattern forms when a stock's price rises to a peak and then declines back to the base of the prior up-move. Then, the price rises above the previous peak to form the "head" and then declines back to the original base. Finally, the stock price peaks again at about the level of the first peak of the formation before falling back down.The head and shoulders pattern is considered one of the most reliable trend reversal patterns. It is one of several top patterns that signal, with varying degrees of accuracy, that an upward trend is nearing its end.

KEY TAKEAWAYS

• A head and shoulders pattern is a technical indicator with a chart pattern of three peaks, where the outer two are close in height, and the middle is the highest.
• A head and shoulders pattern—considered one of the most reliable trend reversal patterns—is a chart formation that predicts a bullish-to-bearish trend reversal.
• An inverse head and shoulders pattern predicts a bearish-to-bullish trend.
• The neckline rests at the support or resistance lines, depending on the pattern direction.

What Is the Head and Shoulders Pattern?

A head and shoulders pattern is used in technical analysis. It is a specific chart formation that predicts a bullish-to-bearish trend reversal. The pattern appears as a baseline with three peaks, where the outside two are close in height, and the middle is highest.
The head and shoulders pattern forms when a stock's price rises to a peak and then declines back to the base of the prior up-move. Then, the price rises above the previous peak to form the "head" and then declines back to the original base. Finally, the stock price peaks again at about the level of the first peak of the formation before falling back down.
The head and shoulders pattern is considered one of the most reliable trend reversal patterns. It is one of several top patterns that signal, with varying degrees of accuracy, that an upward trend is nearing its end..

What Does the Head and Shoulders Pattern Tell You?

The head and shoulders pattern indicates that a reversal is possible. Traders believe that three sets of peaks and troughs, with a larger peak in the middle, means a stock's price will begin falling. The neckline represents the point at which bearish traders start selling.
The pattern also indicates that the new downward trend will likely continue until the right shoulder is broken—where prices move higher than the prices at the right peak.

Advantages and Disadvantages of the Head and Shoulders Pattern

Advantages
Experienced traders identify it easily

• Defined profit and risk
• Big market movements can be profited from
• Can be used in all markets

Disadvantages

• Novice traders may miss it
• Large stop loss distances possible
• Unfavorable risk-to-reward possible