Head and shoulders and of course the inverse head and shoulders are one of the most important patterns to be found when trading and the first thing to consider when meeting such a pattern is the fact that they are reversal pattern. Head and shoulders are to be found after a bullish trend or just before the bullish trend ends and they are signaling exhaustion and the fact that the trend is about to be done.
Forming the Head & Shoulders Pattern
Such a pattern is formed out of the following: two shoulders (left and right) one head a neckline a measured move The first thing to take into consideration is the head as this is the one that is striking, the sense that it is being characterized by a quick spike to the upside (in the case of a head and shoulders pattern) followed by a quick retrace and then price starts to consolidate. Usually consolidation comes around the level where the left shoulder began the consolidation prior to the head spike, and therefore drawing the neckline is both logical and intuitive.
The recordings that are coming with this educational material shows exactly how to draw the neckline and how to trade forex based on such a concept. After the neckline is being in place, looking at similarities between the left shoulder and the right shoulder is the next thing to do and this helps in finding the exact place to enter a trade.
How to Trade When You Notice the Head and Shoulder Pattern Forming
In order to do that what we need to consider is the amplitude (height) on the left shoulder, project it on the right shoulder and there would be a nice place to buy SELL contracts or PUT options based on a head and shoulders reversal pattern. The expiration date depends very much on the time frame such a pattern is identified and more details are to be found by watching the two videos in this article. The next thing to consider is to look for the moment of time when the neckline is broken and the actual moment to buy the put option would be when price is retesting the neckline.
Such a retest is not mandatory and sometimes traders wait for it to com and it never comes. But most of the times it does and that is a great place to engage into buying the put options. The last thing to consider is the measured move and this is calculated by measuring the distance from the head to the neckline and projecting this distance by the time the neckline is broken.
Entering the Trading Position and Time Frame
Until the measured move is coming, look for price to be attracted to the downside, therefore favoring SELLing underlying assets. Because head and shoulders are considered to be reversal patterns, market participants are paying a great deal of attention when they appear on the bigger time frames as turning points can be identified.
If, for example, the pattern appears on the weekly or monthly chart, then you can imagine how powerful the measured move should be and its implications. Regarding binary options trading, there is always the striking price that is the most important, but equally one should look at the expiration date needed for the option to be a winning one.
Use Additional Tools to Determine Expiration Date
The expiration date can be adjusted by watching the time frame the pattern appears and then choosing the expiration date based on a technical retracement, like a Fibonacci sequence. For example, the right shoulder in such a pattern should be similar with the left one in the sense that one should look for almost the same distance traveled by price. In this case, taking a Fibonacci Retracement Tool and measuring the distance traveled on the left shoulder will give a nice striking price on the right shoulder.
The stronger the retracement, the smaller the expiration date should be. Therefore, if trading such a pattern on the daily chart then we can choose even a lower expiration date when compared with one day as the more price retraces for the right shoulder the more attractive lowering the expiration date should be.
Head and Shoulders is a Contracting Triangle
In comparison with Elliott Waves Theory, the head and shoulders pattern is actually representing a contracting triangle, a so called special type of a triangle. It is a well known fact now that a contracting triangle has five legs and they are labeled with letters (a-b-c-d-e). These five legs are corrective and the triangle is evolving between the a-c and b-d trend lines.
Therefore, taking a trend line and connecting the a and c and b and d points, the outcome should be a pattern that contracts, namely the a-c and b-d trend line should meet somewhere on the right side of the chart. However, in order to have the head and shoulders pattern the triangle should be formed from the a and e and b and d trend lines, and this is being called a triangle with the a-e base line.