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Powerful Trading Strategy To Change The Game | Head And Shoulders Secrets For Forex & Stock Market - YouTube
Channel: The Secret Mindset
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An uptrend is defined as a series of higher
highs and higher lows.
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As long as this pattern remains intact, the
uptrend is valid.
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And when lower highs and lower lows are introduced,
it forms the basis for one of the most notorious
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reversal patternsāthe āāhead and shouldersāā.
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In today video, I will show you my own way
to analyze and trade this old-school pattern,
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and I will share exactly what to do to increase
your winning rate when trading this formation.
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The head and shoulders is a bearish reversal
pattern that consists of three main parts:
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the left shoulder, the head, and the right
shoulder.
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The pattern begins as a series of higher highs
and higher lowsāthe classic definition of
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an uptrend.
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That sequence is altered when a low point
is formed that has the same approximate value
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as the previous low.
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The left shoulder and head of the pattern
are now fully formed; this is the first sign
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that a change in trend may be imminent.
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The price rallies from this low point, but
instead of resuming the sequence of higher
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highs, a lower high occurs.
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Often, this lower high is similar in value
to a prior high point that is now the peak
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of the left shoulder.
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Then the price slides back to the previous
low for a third time, forming the right shoulder.
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The pattern is now complete.
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The three lows should be similar in value
and represent an area of horizontal support.
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A line is drawn across the three lows; and
this is known as the āānecklineāā
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of the pattern.
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Think of the head and shoulders pattern as
the transition point between two opposing
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trends.
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The left side of the pattern represents the
end of the uptrend (the final higher high),
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and the right side of the pattern represents
the beginning of the downtrend (the first
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lower high).
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So keep in mind that the location of any reversal
pattern is critical, and that a pattern is
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defined by the price action that precedes
it.
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Most novice trades only use price action to
analyze and trade the pattern, but I like
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to analyze market volume when Iām spotting
a possible head and shoulders
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Volume is an important consideration of the
head and shoulders pattern.
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If a higher high occurs on expanding volume,
that is considered healthy and normal in an
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uptrend.
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However, in an ideal scenario,the head and
shoulders pattern sees volume diminish on
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each successive peak.
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The higher high that forms the peak of the
head should ideally occur on lower volume
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than the previous high, which formed the left
shoulder.
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Volume should diminish further on the third
peak, as the right shoulder forms.
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This demonstrates a lack of enthusiasm on
the part of the bulls, who are losing their
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will to continue buying at higher prices.
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If and when the neckline breaks, that break
should occur on high volume.
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This example shows how volume decreased as
the pattern forms.
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First we have a rally, but the rally came
to an end which also represented the peak
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of the head and shoulders pattern (H).
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See that in general, the volume beneath the
head and shoulders is low compared to the
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rally that preceded it.
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In fact, volume is extremely low on this bounce
from the neckline.
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Once the neckline was broken, volume began
to increase as the price moved lower.
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The neckline is the focal point for traders
who wish to use this pattern to their advantage.
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Since the price advances upward from the neckline
on several occasions during the formation
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of any head and shoulders pattern, we can
assume that some traders were buying at that
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level.
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What can be said of those who took long positions
on the neckline and are still in the trade?
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We know that those buyers, along with any
buyers who entered at higher levels and are
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also still in the trade, will be holding losing
positions if the neckline should break.
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These losing traders will be motivated to
sell, which should help push the price lower.
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Also, aggressive traders will close long positions
and sell short as the price breaks through
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the neckline, without waiting to see if the
price will close below the neckline.
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Other traders, wishing to avoid a false break,
will allow the price to close below the neckline
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before initiating a short position.
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This is considered a safer method of entry,
but it isnāt always feasible because the
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price can move sharply once the break occurs.
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A trader who waits for the price to close
below support may find the price has moved
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far below the neckline, creating a less than
ideal risk/reward scenario.
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A more conservative entry approach for a short
trade would be to wait for the price to close
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below the neckline, and then place an order
to sell short just below the neckline.
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The assumption is that the neckline, which
was the major support level of the pattern,
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should now act as resistance should the price
manage to rally back to that level.
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There is no guarantee that the price will
rally back to the neckline, but if it does,
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the trader is now presented with a āāsecond
chanceāā to sell at resistance within
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the context of a head and shoulders breakdown.
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In this example, we found a head and shoulders
pattern and price broke through neckline support.
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This break of the neckline was the first opportunity
to sell.
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If we extend the neckline to the right, we
see the price rallied into the necklineās
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extension.
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The neckline, formerly support, now acts as
resistance, and the price advance is stopped
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at that point.
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For traders who missed the initial breakdown,
the rally to the neckline is the second chance
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to sell.
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If a head and shoulders breakdown occurs,
how far should we expect the price to fall?
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The size of the this structure holds a direct
relationship with the potential target for
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the trade.
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Therefore, itās important to understand
how to measure the size of the H&S pattern.
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To do so, you need to take the distance between
the high the head and the neckline.
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Now that you have the size of your H&S pattern
on the chart, you should apply this length
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downwards, starting from the initial breakout
through the neckline.
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This is the price move you should expect when
trading the Head and Shoulders setup.
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The Head and Shoulders trade setup should
be used in conjunction with a stop loss order.
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The H&S pattern, like any other pattern, does
not provide a 100% success rate, so you must
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protect your trading account in case price
moves against you.
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The optimal place for your stop loss order
is above the second shoulder on the chart.
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So when you short a market after a Head and
Shoulders breakout signal, you place the stop
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above the 3rd top of the pattern.
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Donāt expect to find the perfect head and
shoulders pattern every time.
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You must be flexible and in real time youāll
find many variations on this formation.
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A fairly common variation on this pattern
is one that contains multiple heads and/or
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shoulders.
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In some cases, the head and shoulders pattern
forms as it normally does but fails to break
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the neckline; instead, it forms a second or
even third right shoulder.
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The fact that this version of the pattern
has multiple right shoulders doesnāt invalidate
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its meaning.
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Hereās an interesting example.
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We have a huge head and shoulders pattern.
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At the time of its formation, the left shoulder
(L) appeared as a possible double top.
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The head also looks similar to a double top,
as does the original right shoulder.
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Instead of breaking the neckline after the
formation of the right shoulder, the pattern
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formed two additional right shoulders before
finally breaking down below the neckline.
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There are a few key insights I want to share
with you.
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Think of these as rules to follow when trading
the head and shoulders pattern.
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1.
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The pattern must form after an extended move
higher
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It can only be a bearish reversal pattern
if it forms after an extended move higher.
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One way to double check is to make sure there
are no immediate swing highs to the left of
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the formation.
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In this example notice all the white space
to the left.
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Thatās what you want to see when trading
any bearish reversal patterns.
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2.
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Neither shoulder can be above the head
The head should always stick out above the
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left and right shoulders.
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And while thereās no exact rule for the
distance, it should be evident from a quick
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glance.
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3.
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The neckline should be horizontal or ascending
but never descending
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If you find a head and shoulders where the
neckline moves from the top left to the bottom
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right, you may want to stay on the sidelines.
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Itās a sign of a āweakā reversal pattern.
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And while you may still enjoy a favorable
outcome, the odds arenāt in your favor.
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Instead you want to see an ascending neckline.
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In my experience, the steeper the angle of
the neckline, the more aggressive the breakout
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and reversal is likely to be.
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4.
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The left and right shoulder āoverlapā
to some degree.
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Each shoulder must share a portion of the
same horizontal plane.
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They donāt need to overlap entirely, but
they do need to share a portion of the highlighted
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area.
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If you find a price structure that doesnāt
fit this description, you could add it to
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your watch list, but it isnāt technically
a head and shoulders.
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And hereās how I personally validate a head
and shoulders pattern.
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If you followed my channel before, you know
that Iām a big fan of divergences.
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A divergence occurs when an indicator and
the price of an asset are heading in opposite
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directions.
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A Negative divergence happens when the price
of an asset is in an uptrend and a major indicator,
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in this case the RSI, heads downward.
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Often you will see a divergence pattern between
the left shoulder and the Head, like in this
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example.
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This is a powerful leading signal, and a divergence
could add fuel to a potential breakout below
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the neckline.
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Also, you could have a hidden divergence between
the Head and the right shoulder, meaning a
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lower high between the head and the right
shoulder and a higher high on the indicator.
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Here are several examples of valid signals.
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As always, if you learned something new and
found value, leave us a like to show your
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support, subscribe to our channel and hit
the bell icon to stay in touch when we release
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new videos.
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Until next time.
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