When it comes to technical analysis models in financial investment, head and shoulders pattern is always one of the popular terms mentioned by many people. This model not only helps identify market trends. But also brings good trading opportunities for investors. To learn more, let’s refer to the following article on Crypto Trading!
Introducing the head and shoulders pattern
Below, we will learn about the definition, advantages, and disadvantages of this model:
Definition of reversal candlestick pattern: head and shoulders pattern
The head and shoulders pattern (Head and Shoulders) is a model that describes price fluctuations and signals future trend reversals. Long used in crypto, stock, and virtual currency investment methods, this model helps investors predict price fluctuations with near-accuracy.
This pattern is depicted in the form of a baseline chart. The pattern consists of three peaks: two outer peaks of approximately equal height and the highest middle peak. From the head and shoulders pattern, investors can predict price movements from up to down or vice versa.
The head and shoulders model is widely used in stock trading. It aims to assess the market and the trend of stock movements. The advantages that the model brings include:
- Determine price ranges to set profit targets and limit risks based on the model.
- Effective in placing take profit and stop loss orders based on the tops and bottoms of the pattern.
- When the model is perfect, investors can determine the upward or downward trend of the stock code in the next period.
The only major drawback of this pattern is that the trend reversal is too strong. This affects price movements in the same direction.
See also: Reversal candlestick pattern: everything should know
Advantages and disadvantages of models in technical analysis
Advantage:
- This pattern is very recognizable to experienced traders.
- Easily identify short and long entry levels.
- Stop distances and confirmed open and close orders are all easy to set up.
- The time frame for the model is quite long.
- The market can change dramatically, going from entry price to closing price.
- This model can be used in forex and stock trading.
Defect:
- The head and shoulders pattern may not appear with a flat neckline, which can put off new traders.
- Large downward movements that persist over long time frames will result in large stop-loss distances.
- If the price falls, the neckline could be retested, putting some traders at risk.
Meaning of head and shoulders candlestick pattern in technical analysis
The head and shoulders technical analysis model is widely used in stock trading, helping investors analyze and grasp the market, although a perfect model rarely occurs. The important meanings of this model include:
- Price trend prediction: Investors can predict the price. The price will move from up to down and vice versa. This helps investors come up with reasonable stock buying and selling strategies.
- Determine stop loss and price target: This model helps investors determine reasonable stop loss points and upcoming price targets, optimizing profits and minimizing financial risks.
- Characteristics of the perfect pattern: The perfect head and shoulders pattern is characterized by equal bottoms and tops. However, this is very rare. It is common to see patterns where the tops of the left and right shoulders are not equal and the bottoms are different.
- Role of Price and Volume: Price and volume play an important role in analyzing this pattern. Market momentum is weakened if volume does not increase sharply despite the peak in the head area. The number of shares is narrowed and the selling trend is dominant, creating a pattern with a lower right shoulder.
Distinguish from other typical technical models
The head and shoulders pattern, triangle pattern, and cup handle pattern are all popular technical analysis patterns used to predict price trends in financial markets. However, each pattern has its own distinct characteristics and meanings:
| Characteristic | Head and shoulders pattern | Triangle model | Cup and handle pattern |
| Shape | Three peaks (head and shoulders) | Converging or Oscillating Triangles | U-shaped “cup” with “handle” |
| Meaning | Forecast of bullish trend reversal | Forecast trend reversal or continuation | Uptrend forecast to continue |
| Using | Buy when price breaks neckline, cut loss at top | Depends on the type of triangle and breakout direction | Buy when the price breaks the handle, cut a hole at the bottom of the cup |
Factors that form the head and shoulders pattern
To represent an up or down trend, the model needs to have all of the following elements:
- Left Shoulder: The formation begins with an uptrend in the stock price along with high trading volume. After the top is formed, the market begins to correct downwards to form a bottom.
- Middle Top: After the bottom of the left shoulder is formed, the market will correct up again. At the same time, it will create a higher top than the top of the left shoulder. Trading volume increases sharply but is usually lower or equal to the stage of forming the left shoulder. After the middle top is formed, the stock price will correct down. This creates a bottom equal to the bottom of the left shoulder. Connecting these two bottoms will form a neckline.
- Right Shoulder: This is the stage where the stock tries to recover. The price starts to gradually increase again. It creates a lower peak than the middle peak and then reverses and decreases. This correction breaks the neckline. From there, it is predicted that the price will continue to go down.
- Neckline: The neckline plays a very important role in the bearish head and shoulders pattern. It is considered a resistance level for investors looking for a bounce. It can be a straight line or slightly inclined.
This reversal candlestick pattern with these elements helps investors analyze and predict stock price trends accurately and effectively.
Classification of head and shoulder pattern
Head and shoulders reversal candlestick patterns are divided into 2 types.
Positive head and shoulders reversal candlestick pattern
The head and shoulders pattern is formed from an upward trend in price creating a peak and then moving down to create a bottom. Next, the price will rise again to create a higher peak called the top, then go down again to create a bottom. Finally, the stock price recovers and increases again, creating another lower peak and then immediately turning back down.
The neckline is defined by connecting two bottoms, with a slope that can be up or down. The downward slope of the neckline will have greater reliability in the positive model. When the pattern completes and the price goes down, breaking the neckline, forecasting the next downtrend.
Head and shoulders reverse pattern
The inverted head and shoulders pattern has the opposite price movement graph compared to the positive pattern. Form valleys. This pattern starts with a decrease in price, creating a bottom at the shoulders. Then the price turns back to create a peak.
Once the first peak is formed, the price may continue to fall sharply. The price is a lower low than the shoulder, called the head. Price then turns around and rises again, making a second high equal to or higher than the first high. The price continues to fall sharply, making a second low, called the shoulder, and then rises again, breaking the neckline. The inverted pattern shows that the downtrend of the security has been reversed.
See more: OKX: open an OKX account – Reputable crypto exchange
How to invest in crypto with a head and shoulders pattern effectively
The Head and Shoulders pattern allows investors to identify price trends that reverse from up to down and vice versa. Below are some effective ways to invest with this pattern that many investors are applying:
- Execute a sell order: Normally, investors will execute a sell order when the market appears head and shoulders. However, to sell effectively, you need to wait for the moment when the price breaks the neckline. This is the moment to determine that the price has reversed.
- Measure the distance and height of the points: The investor draws the head and shoulders pattern. Measure the distance and height of the points to determine the profit range. Place a stop loss order using the shoulders. Then exit the order at the intersection of the neckline.
- Understand the imperfection of the model: No model is 100% effective. If the market does not follow the model, the stop loss may be affected. Therefore, investors need to accurately assess the model being shown. Decide to place orders based on the actual fluctuations of the market, and avoid relying too much on this model.
Conclude
Head and shoulders pattern is a useful technical analysis tool in stocks. By understanding its characteristics and related details, you can improve your chances of success in crypto investing. Don’t forget to combine other tools and models to ensure the effectiveness of each transaction. Don’t forget to learn more about other aspects of the investment field through the following articles on Crypto Trading.
FAQs
Head and shoulders pattern là gì?
This pattern is a chart pattern used in technical analysis. It is used to predict a reversal of a price trend. The pattern consists of three peaks: two shoulder peaks of equal height and a higher central head peak.
How to place stop loss in the pattern?
Stop-loss orders are usually placed at a higher price (in a bullish pattern). Lower (in a bearish pattern) than the right shoulder. The purpose is to minimize risk when the price does not move as predicted.
What role does the neckline play in a reversal candlestick pattern?
The neckline plays an important role in determining the completion of the pattern. When the price breaks the neckline, it is a signal that the price trend has reversed.
