EURUSD 1.1787 USDJPY 112.14 USDCAD 1.2774 EURCZK 25.557 USDCZK 21.677 EURPLN 4.2304 USDPLN 3.5887
EURUSD 1.1787 USDJPY 112.14 USDCAD 1.2774 EURCZK 25.557 USDCZK 21.677 EURPLN 4.2304 USDPLN 3.5887

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Head and shoulders formations are popular due to their alleged accuracy in the prediction of trend reversals

Rule of thumb

Sometimes a false signal occurs, when prices after a break-out through the support line come back again to the previous levels - in such a case one may say that the Head and Shoulders formation has failed

 

However, once crossed, the support line should be considered as a resistance line. As long as the prices remain below this level, a downward market tendency may be expected

Chart type: Bar chart, candlesticks

Applies to: Reversal

Significance: High

 

A Head and shoulders formation is a very common and popular reversal formation among investors. The most basic pattern type of head and shoulders consists  of one (left) shoulder, one head, and one (right) shoulder. Head and shoulders formations may be divided into top and bottom formations. The head and shoulders top represents the reversal of a rising trend, while the head a shoulders bottom represents the reversal of a descending trend.

 

head and shoulders

 

The head and shoulders top formation may be shaped after a rising trend, which then falls back, forming a local maximum. This local maximum is called the left shoulder. Soon after the shoulder is formed, a price tends to rise and fall back again to form the head, which is another local maximum, but higher than the shoulder (both left and right ones).

 

As soon as the head is formed, i.e. a price stops falling back and starts rising again to form the right shoulder, a line should be drawn connecting the local low price points of the formation (the lows between the shoulders and the head). This line is then called the neckline, which may be horizontal, and have an upward or downward slope. The neckline in this formation functions as a support line, which when crossed, it is most likely that the price will continue its fall.

 

How to use it with MetaTrader 5:
Look for a clear rising trend of price, which then falls back forming a local maximum:

  • The level where the price starts to rise again, to form the head, is called the neckline (left neckline).
  • The head will consist of another local maximum higher than the shoulder, i.e. from the neckline the price will rise and fall back again.
  • The next level of the neck, i.e. the point where a price falls back and starts rising to form the right shoulder, is very important. A straight line can be drawn, using the [Draw trendline] button, starting from the left neckline, through to the right neckline, and forward.
  • This line, not necessarily horizontal, is a potential indicator, that when the right shoulder is completely formed, i.e. a price crosses down the neckline, a significant fall in price can be expected.

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