Sophia Todorova has a background in teaching and psychology, and as such relishes the idea of assisting new traders on their journey to Forex trading success. Technical Analysis is her passion. The charts speak, and she listens.
My last article in the series looked at horizontal trading ranges. Another way in which buy and sell zones can be identified and traded is with the use of trendlines. A trendline does this by emphasizing important support and resistance points that, once broken, represent a reversal from bulish to bearish, and vice versa. A very popular pattern that results as price moves from one zone to the next in this way is a ‘head and shoulders’ pattern. The chart below shows the pattern, and is also labeled with general guidelines for trading the buy and sell zones which result from the formation. I deliberately used an example which is not exactly symmetrical because head and shoulders formations can vary quite a bit. For example, the right shoulder can be higher or lower than the left one, depending largely on the angle of the trendline and the strength of the market at a particular point in time.
Guidelines for Trading a Head and Shoulders Pattern
In reference to the labeled chart below, the market was constantly making up ABCDs until the reversal took place. The last ‘D’ that is made before the trendline gets broken becomes the ‘head’ in the formation.
Following the trendline break, price needs to go down to test or take out the last ‘C’ that was made prior to the trendline break.
Next, for a good risk: reward ratio, it would have been a good idea to wait for the last retest of the trendline before shorting.
In this case, a stop-loss could be placed above the left shoulder. Its angle places it a safe distance from the market. Generally though, where possible, the safest placement for stop losses would be above the head formation.
Providing this is not just a small pull-back, the market should start making lower lows, and the last ‘D’ from the uptrend will now become the ‘A’ of the new downtrend.
Targets for profit can be projected using the Fibonacci extension levels tool in addition to visible resistance and support. I like to take first profit at the level where the last ‘C’ of the old trend is located.
Thank you for reading. Please feel free to share your questions and comments 🙂
You can also read my last post on the Audusd here: http://winnersedgetrading.com/technical-analysis-trading-opportunities-4/
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