Head and Shoulders
This pattern is seen in an uptrend movement with three consecutive rallies. The 1st and 3rd rallies are of the same height (“shoulders”), while the second rally is the highest (“head”). The lowest points of the 1st and 3rd rallies serve as the “neckline”.
The neckline acts as the support during the rallies, but when this is broken through after the 3rd rally, then neckline becomes a resistance. When the new resistance is held, price is expected to fall approximately equal to the distance between the head and the neckline.
In this pattern, we enter the trade with “short” when price goes below the neckline.
Inverse Head and Shoulders
Inverse head and shoulders is the exact opposite of the head and shoulders pattern. Instead of an upward trend, this is characterized by a downward trend with 3 consecutive rallies, 2nd rally being the highest of the three. The highest points of the 1st and 3rd rally are the points where neckline is drawn.
The neckline serves as the resistance. Once breakout occurs after the 3rd rally, the neckline now becomes the new support. When the new support is held, price is expected to rise approximately equal to the distance between the head and the neckline.
In this pattern, we enter the trade with “long” when price goes above the neckline.
Note: When head and shoulders chart pattern occur, it signifies a reversal in the price movement. After the breakout, a retracement may occur, causing the currency pair to return back to its previous trend. It is therefore recommended to wait for the retracement and enter trade when currency pair fails to push through the new resistance or new support (for reversal).