“pattern Recognition Strategies: Identifying Profitable Setups In Australia” – The Head and Shoulders chart pattern is a popular and easily visible pattern in technical analysis that shows a baseline with three peaks, the middle peak being the highest. The head and shoulders chart shows a reversal of a bullish-to-bearish trend and signals that an uptrend is coming to an end.

The pattern appears on all time frames and can therefore be used by all types of traders and investors. Entry levels, stop levels and price targets make the formation easy to implement, as the chart pattern provides important and easily visible levels.

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First we will look at the formation of the head and shoulders pattern and then the reverse head and shoulders pattern.

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The neckline is the level of support or resistance that traders use to determine strategic areas to place orders. To place the neck, the first step is to locate the left shoulder, head, and right shoulder on the chart.

In the standard head and shoulders pattern (market top), we connect the low after the left shoulder with the low created after the head. This creates our neck – the dark blue line on the lists.

We will discuss the importance of the neck in the following section. In a reverse head and shoulders pattern, we connect the high after the left shoulder with the high formed after the head, thus creating our neckline for this pattern.

It is important that traders wait for the pattern to complete. This is because a pattern may not develop at all, or a partially developed pattern may not be completed in the future. Partial or nearly completed patterns should be monitored, but no changes should be made until the pattern breaks the neck.

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In the head and shoulders pattern, we wait for the price action to move lower than the neckline after the top of the right shoulder. For inverse head and shoulders, we wait for price movement above the neck after the right shoulder is formed.

A trade can be initiated once the pattern is complete. Plan your trade in advance, write down your entry, stop and profit target, as well as note any variables that will change your stop or profit target.

The most common entry point is when a breakout occurs – the neck is broken and a trade is taken. Another entry point requires more patience and comes with the possibility that the move may be missed entirely. This method involves waiting for a pullback to the neck after a breakout has already occurred. This is more conservative in that we can see if the pullback stops and the original breakout direction resumes, the trade may be missed if the price continues to move in the breakout direction. Both methods are shown below.

In the traditional market top pattern, the stops are placed directly above the right shoulder (top pattern) after the neck is penetrated. Alternatively, the head of the pattern can be used as a stop, but this is likely to be a much greater risk and thus reduces the reward-to-risk ratio of the pattern. In the reverse pattern, the stop is placed just below the right shoulder. Again, the stop can be placed at the top of the pattern, although this exposes the trader to greater risk. In the chart above, the stop would be placed at $104 (just below the right shoulder) when the trade was taken.

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The profit target for the pattern is the price difference between the head and the low point on both shoulders. This difference is then subtracted from the breakout level of the neck (at a market top) to provide a price target for the downside. For a market bottom, the difference is added to the cut-off price to provide a price target on the upside.

The SPDR S&P 500 ETF Trust (SPY) is a heavily traded exchange-traded fund (ETF) and represents the broader market. The profit target for the reversed head and shoulders pattern would be:

$113.20 (this is the highest after the left shoulder) – $101.13 (this is the lowest part of the head) = $12.07

This difference is then added to the breakout price (subtracted in the case of a regular head and shoulders pattern). The department price is right around $113.25, giving us a profit target of $125.32 ($113.25 + $12.07).

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Sometimes investors have to wait a long time – up to several months – between spotting the breakout and reaching the ideal profit target. Monitoring your trades in real time can help you predict their results.

No pattern is perfect, nor does it work every time. Nevertheless, there are several reasons why the chart pattern theoretically works (the market top will be used for this reasoning, but it applies to both):

As mentioned, the pattern is not perfect. Here are some potential problems with trading a head and shoulders pattern:

Head and Shoulders is a chart pattern used by technical analysts. This chart has a baseline with three distinct peaks. There are two on the outside that are the same height. The third, shown in the middle, is the tallest. So how do you read it? It signals that there is a trend reversal from a bullish to a bearish cycle, where an uptrend is coming to an end. Remember that there are never perfect patterns, which means there will always be some noise in between.

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Make sure you wait for the pattern to run its course before you start trading it. This means you have to wait until the neck breaks before you jump in. If you go in too early, the pattern may not develop or go all the way through at all. You basically wait for the price to move lower than the neck after the top of the right shoulder. Make sure you note your entry, stop and profit targets. You should also note any factors that will change your price target.

There are a few reasons why the head and shoulders pattern works. One of the main advantages is that you won’t be competing with a lot of aggressive buyers since sellers are already entering the market when prices are falling out of their heads. If you enter at the wrong point, such as the last wave or during the rally, you can end up with big losses. Another pitfall is that the price can be forced towards the price target due to the fact that losing traders are forced to exit their positions at the neck.

If you are not a patient trader, you may find some frustrations using head and shoulders patterns. That’s because you have to wait for them to complete. If you enter too early, the pattern may not go its way. This means you can wait a while. Another downside is that you don’t always hit the profit target and you may find that the pattern isn’t even tradable.

Head and shoulders patterns occur in all time frames and can be seen visually. Although subjective at times, the complete pattern provides entries, stops and profit targets, making it easy to implement a trading strategy.

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The pattern is composed of a left shoulder, a head, then a right shoulder. The most common entry point is a breakout of the neck, with a stop above (the market top) or below (the market bottom) the right shoulder. The profit target is the difference between the high and low of the pattern added (market bottom) or subtracted (market top) from the breakout price.

The system is not perfect, but it provides a method for trading the markets based on logical price movements.

Requires authors to use primary sources to support their work. These include white papers, government data, original reporting and interviews with industry experts. We also refer to original research from other reputable publishers where appropriate. You can learn more about the standards we follow to produce accurate, unbiased content in our Editorial Guidelines.

The offers shown in this table are from partnerships that receive compensation from. This compensation may affect how and where listings are displayed. does not include all offers available on the market. Research shows that the most reliable and profitable chart patterns are Head & Shoulders, with a success rate of 89%, Double Bottom (88%), and Triple Bottom and Descending Triangle (87%). ). The most profitable chart pattern is the Rectangle Top, with an average profit of 51%.

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We know the success rates and profitability of chart patterns because Tom Bulkowski, the author of The Encyclopedia of Chart Patterns, has spent decades researching this topic. I thank Tom for permission to use some of his valuable insights.

We independently research and recommend the best products. We also work with partners to negotiate discounts for you and may earn a small fee through our links.

This table shows the chart pattern success rate/probability of a price increase in a bull market and the average price increase after exiting the pattern. For example, the inverse head and shoulders pattern has an 89% chance of success when the price moves up through the resistance level, and the average profit is 45%.

Performance data courtesy of https://thepatternsite.com/ permission granted by Tom Bulkowski. *Number for a break down through the support line.

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