Traders tend to pay too much attention to the right time to enter the transaction, but seldom pay attention to formulating strategies to exit positions. If you sell too early, you will leave considerable gains, and if you hold the position for too long, the market will quickly recover profits. Therefore, it is necessary to confirm and close the transaction immediately when the trend starts to reverse.
A classic setting that is considered reliable in detecting trend reversals is the head and shoulders (H&S) mode. In a long time frame, H&S patterns are not often formed, but once they are formed, traders should pay attention and take corresponding actions.
Let’s look at several ways to identify H&S patterns and when to act on them.
Head and shoulders foundation
The H&S pattern formed after the bull market phase, indicating that a reversal may be coming. As the name suggests, this form consists of a head, left shoulder, right shoulder, and a distinct neckline. When the pattern is completed, the trend usually reverses direction.
The figure above shows the structure of the H&S pattern. Before the setting is formed, the asset is in an upward trend. At the peak formed by the left shoulder, the trader booked profit, which led to a decline. This formed the first trough, but it is not yet a strong enough signal to trigger a trend change.
The lower level once again attracted buying because the trend is still bullish, and buyers managed to push the price above the left shoulder, but they were unable to maintain the upward trend.
The profit-taking by the bulls and short selling by contrarian traders pushed prices down and found support near the previous low. Connecting these two troughs forms the set neckline.
As the price rebounded from the neckline, the bulls tried again to resume the upward trend, but when the price reached a height close to the left shoulder, the profit ended and the rebound ended.
This lower peak forms the right shoulder, which is usually in line with the left shoulder. The upward trend reversed and the selling momentum increased. In the end, the bears succeeded in pulling the price below the neckline. This completes the bearish pattern and the trend reverses from bullish to bearish.
Use H&S model to find trend reversal
Bitcoin (Bitcoin) After breaking through USD 20,000 in December 2020, it began to rise strongly. The BTC/USDT pair hit a local high of US$61,844 on March 13, and the price pulled back and formed a low on March 25. This local high point is the left shoulder.
The bulls see the decline as a buying opportunity because the trend is still rising. Aggressive buying subsequently pushed the price above US$61,844, and the currency pair hit a record high of US$64,854 on April 14. This level attracted selling, driving prices lower and forming the second trough on April 25. The middle high point, higher than the other peaks, forms the head.
Another attempt by the bulls to resume the upward trend failed on May 10. This formed the right shoulder, and the subsequent correction fell below the neckline of the pattern. A break below and close below the neckline on May 15 completed this bearish setup.
Sometimes, after the breakout, the price retests the breakout level from the neckline, but when the momentum is strong, the retest may not happen, as shown in the chart above.
To calculate the mode target for this setting, determine the distance from the neckline to the top of the head. In this case, the value is $15,150. Then subtract this distance from the breakdown point on the neckline to reach the minimum target goal.
In the example above, the failure occurred at approximately $48,000. This projected model target is $32,850. This number should be used as a guide, because sometimes the decline exceeds the target, and in other cases, the downward trend ends without reaching the target.
Sometimes head and shoulders fail
Sometimes traders will take counter-trend positions before the price drops below the neckline of the H&S pattern. At other times, a break below the neckline will not see subsequent selling, and the price will rise above the neckline. These situations may lead to setup failures, trapping those aggressive shorts who are forced to cover their positions, leading to short squeeze.
Cardano (have) Starting from the level of 0.10 USD on November 20, 2020. The January uptrend encountered resistance in the USD 0.35 to USD 0.40 area, and the H&S model began to develop. The price fell to the neckline on January 27, but the bears were unable to sink and closed the ADA/USDT pair below support.
When the price rebounded from the neckline on January 28, it was a sign that market sentiment was still bullish. There was a small problem on January 30 and 31, when the bears tried to stop the rise near the right shoulder, but continued buying by the bulls pushed the price above the head on February 1. The top of this breakout pattern is invalid.
When the bearish setup fails, it will catch several aggressive sellers going the wrong way. This leads to short-term squeezing and pushing up prices. The same thing happened in the above example, the currency pair surged in February.
The H&S mode is considered a reliable reversal mode, but there are some points to keep in mind.
Compared to an upwardly sloping neckline, a downwardly sloping or flat neckline is considered a more reliable mode. Traders should wait for the price to fall and close below the neckline before starting to trade. Preemptive setting can lead to losses, because a failed bearish pattern can lead to a strong rebound.
The pattern target should only be used as a guide, because sometimes the price may overshoot and continue to move downward, while at other times, it may reverse direction before reaching the target target.
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