How to Trade $GS the Head and Shoulders Pattern 02-25-22 Friday

The head and shoulders chart pattern, which depicts a baseline with three peaks, the middle peak being the highest, is a common and easy-to-spot pattern in technical analysis. A bullish-to-bearish trend reversal is seen on the head and shoulders chart, indicating that an upward trend is nearing its completion.

The pattern may be employed by all sorts of traders and investors because it appears on all time periods. The chart pattern gives crucial and immediately visible levels, making entry levels stop levels, and price goals simple to apply.

What Head and Shoulders Patterns Looks Like

• Left shoulder: Price rise followed by a price peak, followed by a decline.

• Head: Price rise again forming a higher peak.

• Right shoulder: A decline occurs once again, followed by a rise to form the right peak, which is lower than the head.

Formations are rarely perfect, which means there may be some noise between the respective shoulders and head.

Inverse Head and Shoulders

• Left shoulder: Price declines followed by a price bottom, followed by an increase.

• Head: Price declines again forming a lower bottom.

• Right shoulder: Price increases once again, then declines to form the right bottom.

Again, formations are rarely perfect. There may be some market noise between the respective shoulders and head.

Placing the Neckline

Traders utilize the neckline to discover critical spots to place orders based on the amount of support or resistance. The left shoulder, head, and right shoulder must all be located on the chart before the neckline can be placed. We connect the low formed after the left shoulder with the low created after the head in the traditional head and shoulders pattern (market top). The dark blue line on the charts is our "neckline" as a result of this. In an inverted head and shoulders design, the high created after the left shoulder is connected to the high formed after the head, forming the pattern's neckline.

How to Profit from the Pattern

It's critical for traders to wait for the pattern to finish. This is because a pattern may not develop at all or may not finish in the future if it is only half established. Patterns that are partially or almost finished should be monitored, but no trades should be made until the pattern has broken the neckline.

After the top of the right shoulder, we look for price action to move lower than the neckline in a head and shoulders pattern. After the right shoulder has developed, we wait for price movement over the neckline for the inverse head and shoulders.

When the pattern is complete, a trade can be started. Prepare for the trade ahead of time by writing down the entry, stops, and profit goals, as well as any circumstances that may affect your stop or profit objective.

When the neckline is broken and trade is taken, this is the most popular entry point. Another entry point requires additional patience and the risk of the move being overlooked entirely. After a breakout has occurred, this step includes waiting for a pullback to the neckline. This is more conservative since we can watch if the retreat ends and the original breakout direction persists. If the price continues to move in the breakout direction, the trade may be missed. Both ways are demonstrated below.

Placing Your Stops

After the neckline is breached, the stops are put slightly above the right shoulder (topping pattern) in the classic market top pattern. Alternatively, the pattern's head can be employed as a stop, but this carries a much higher risk and so diminishes the pattern's reward to risk ratio. The stop is set slightly below the right shoulder in the inverted pattern. The stop can be put at the head of the pattern once again, but this increases the trader's risk. Once the trade is taken, the stop would be put at $308 (just below the right shoulder) in the preceding chart.

Identifying Your Profit Targets 

The profit target for the pattern is the price difference between the head and the low point of either shoulder. This difference is then subtracted from the neckline breakout level (at a market top) to provide a price target to the downside. For a market bottom, the difference is added to the neckline breakout price to provide a price target to the upside.

Why Does the Head and Shoulders Pattern Work?

No pattern is flawless, and it does not always work. However, there are multiple reasons why the chart pattern works theoretically (the market top will be utilized for this rationale, although it applies to both.

As prices decline from the market high (head), sellers have begun to join the market, and purchasing has become less active.

As the neckline is reached, many investors who bought in the final wave higher or on the rally in the right shoulder are now proving incorrect and suffering huge losses—it is this large group that will now depart positions, sending the price toward the profit target.

The stop above the right shoulder is sensible because the trend has switched downwards—the right shoulder has a lower high than the head—and the right shoulder is unlikely to be broken until the uptrend returns.

The profit goal believes that individuals who were incorrect or acquired the securities at an inopportune moment would be compelled to sell their holdings, resulting in a reversal of comparable scale to the topping pattern that just happened.

The neckline is the point at which many traders will feel pain and be driven to quit positions, causing the price to rise toward the price goal.

Volume may also be monitored. We would ideally prefer volume to grow as a breakthrough occurs during inverse head and shoulders formations (market bottoms). This indicates greater purchasing interest, which will push the price closer to the objective. Declining volume indicates a lack of interest in the upward advance and should be viewed with caution.