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How To Trade A Head And Shoulders Pattern

Patrick Stockdale
Written by Patrick Stockdale | May 19, 2022

A head and shoulders pattern is a bearish technical analysis chart pattern that signals that the price of a market is reversing from bullish to bearish.

A trader will typically use the head and shoulders pattern to find short opportunities in a market.

The construction of a head and shoulders pattern involves the head with two shoulders on either side of the head and also a support level called the neckline.

These components are important areas to understand when trading the head and shoulders pattern.

To trade a head and shoulders pattern:

  1. Enter a short position when the price breaks below the neckline support level: A trader will wait for the price of a market to break down below the neckline area. Once the price breaks down below this level, they will enter into a short trade position. Ideally, a trader will like to see an increase in volume on the breakdown.
  2. Place a stop-loss order either at the resistance level of the right shoulder or just above the neckline level: A trader has two options when setting a stop-loss level. Place it at the resistance level of the right shoulder or place it just above the neckline level.
  3. Set a profit target: A profit target is set by taking the distance between the high price of the head area and the low of the neckline price level and subtracting it from the neckline downwards. The profit target will then be set at whatever price this works out to be.

Below are visual illustrations of every step of trading a head and shoulders pattern from entering into the trade to setting stop losses and profit targets.

Head And Shoulders Pattern Entry Point

Head and shoulders pattern entry point example

The first step of trading a head and shoulders pattern is entering into a short trade position.

The price chart above illustrates where to enter a short position on a head and shoulders pattern.

When trading a head and shoulders pattern, potential entry points for a short position can be entered in two different ways including:

  • Entering a short position on a breakdown of the neckline support level
  • Wait for the price to break down below the neckline and then retesting the neckline level to enter the trade

The two different options of entering a short position when trading a head and shoulders pattern are labeled on the price chart above as "short entry" and "alternative short entry".

The alternative short entry point is when the price retests the neckline level.

Head And Shoulder Pattern Stop-Loss Level

Head and shoulders pattern where to place stop-loss

The next step in trading a head and shoulders pattern is where to place a stop-loss order.

When trading a head and shoulders pattern, there are two potential areas to place a stop-loss level including:

  • Placing a stop-loss order just above the right shoulder resistance level price
  • Placing a stop-loss order just above the neckline level after the price breaks down below it

The two different areas options for where to place a stop-loss order are labeled on the price chart above as "Stop-loss level" and "Alternative stop-loss level".

The alternative stop-loss level is optimal to get a higher reward to risk ratio but it also means a trader can be stopped out of a trade prematurely.

Head And Shoulders Pattern Price Target

Head and shoulders pattern where to set price target

The final step of trading a head and shoulders pattern is setting a price target for the trade.

A price target for a head and shoulders pattern is set by taking the distance between the top of the head and the neckline level and subtracting the distance from the neckline.

On the price chart above, the profit target area is labeled "price target".

For example, if the distance between the head and a neckline level is $10 and the neckline price level is $30, the price target level will be the neckline level of $30 minus the $10 distance between the head and the neckline level. In this example, the price target would be set at $20.

Head And Shoulder Pattern Trade Examples

Below are chart examples of trading a head and shoulders pattern in different markets.

Example Of Trading A Head And Shoulders Pattern In The Stock Market

Trading a head and shoulders pattern in the stock market

On the price chart of Amazon stock above, there is an example of a head and shoulders pattern short trade from start to finish.

When the price of Amazon stock breaks down below the neckline support level, a short trade is entered (labeled "Short Entry").

A stop-loss order is placed just above the right shoulder level(labeled "Stop-Loss Level").

The price target is set at the same distance from the head and the neckline and subtracted down (labeled "Price Target").

Interestingly, in this example, the price reversed right at the price target level.

This is a full trade example of trading a head and shoulders pattern in the stock market from start to finish.

‍Example Of Trading A Head And Shoulders Pattern In The Forex Market

Head and shoulders pattern trade example in the Forex market

On the price chart of the GBP/USD forex currency pair, there is an example of a head and shoulders pattern short trade from beginning to end.

The price of the currency pair breaks down below the neckline and a short trade is entered at this level (labeled "short entry").

The stop-loss for the short trade on GBP/USD is placed just above the right shoulder of the pattern (labeled "stop-loss level").

The price target is set as the difference between the head and the neckline and subtract that number from the neckline area to get the target level. It is labeled "Price Target" on the chart.

Example Of Trading A Head And Shoulders Pattern In The Commodities Market

Head & Shoulders pattern trading in commodities market

On the price chart of Corn futures above, there is an example of a head and shoulders trade from start to finish.

A short entry is triggered on the head and shoulders pattern in the Corn futures market when the price breaks down below the neckline.

The stop-loss level is placed at the high price of the right shoulder with a target place set as the distance between the head and the neckline subtracted from the neckline price.

Frequently Asked Questions About Trading The Head And Shoulders Pattern?

Below are some frequently asked questions on trading the head and shoulders pattern.

Is It Hard To Trade A Head And Shoulders Pattern?

Trading a head and shoulders pattern is relatively easy to do once a trader follows the steps of where to enter the short position, where to place a stop-loss order and where to set price targets.

However, traders can find it difficult when they trade with their emotions rather than following the head and shoulder pattern rules.

Where Is The Best Place To Set A Stop-Loss Level When Trading A Head And Shoulders Pattern?

The best place to set a stop-loss when trading a head and shoulders pattern will depend on the risk tolerance of the individual trader. Most traders choose to set a stop-loss just above the neckline level after the price breaks down below the support level.

This is in contrast to the original head and shoulder pattern rules which state that a stop-loss should be placed above the swing high price of the right shoulder.

Should A Trader Short A Head & Shoulders Pattern On The Break Down Of The Neckline Or Wait For A Retest?

Ideally, a trader will enter a short trade when the price of a market breaks down below the neckline with increased selling volume.

A market will not always retest the neckline area after a breakdown meaning if a trader waited for a retest, they may miss the trade opportunity.