What Is the Head and Shoulders Pattern in Crypto Trading?

Candlestick patterns have been a major source of market information for many years. They provide detailed information that includes the market’s current price, opening price, closing price, and much more information that traders need to make informed trading decisions. One of the most common patterns is the head and shoulders pattern, which makes it easy to spot directional changes in the market.

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What Is the Head and Shoulders Candlestick Pattern?

Traders check the head and shoulders candlestick pattern to spot a possible change in a market’s direction. When the pattern forms, an ongoing bullish trend will likely turn bearish. The pattern comprises three peaks: the head and the two shoulders (the left and the right).

How the Head and Shoulders Pattern Is Interpreted

The head and shoulders pattern resembles the human head and shoulder structure. The structure has three peaks, with the head being the middle and highest peak. The shoulders are lower than the head.

The Left Shoulder

The left shoulder is the first part of the structure, and it is formed by an upward price movement, followed by a minor price correction.

The Head

The middle structure is the head, which is created when the price returns to a point higher than the previous high made by the shoulder before the price drops again.

The Right Shoulder

The right shoulder is the third and last peak of the structure. It is formed by another upward price movement that is not as high as the head; the final price decline also follows this.

The Neckline

The neckline serves as a support carrying the whole structure. You can also see it as a robust support or resistance to price. Therefore, when the price breaks below the neckline, it is expected to form a price support, while a break above the neckline is expected to form a price resistance.

How to Use the Head and Shoulders Pattern in Crypto Trading

Now you know what the head and shoulders pattern looks like, how can you use it for crypto trading?

It Is Not Always a Perfect Structure

The head and shoulders pattern will not always form a perfect head and shoulders structure. It comes in different variations, and if you are not careful to spot it, you may miss out on many trading opportunities. However, it becomes easier to notice as you use the pattern more often.

Waiting for the Neckline Break

You can trade with various methods when using the head and shoulders pattern. One of the most popular ways is to wait for the neckline breakout before selling. Then, after the bearish breakout, traders look for more confirmations for trade entry.

Setting Your Stop Loss

Traders also have varied approaches to determining their stop-loss levels. However, if you use the head and shoulders pattern, the best place to put your stop-loss is above the neckline. Setting your stop loss at a level you don’t expect the price to reach is recommended.

The Inverse Head and Shoulders Pattern

The inverse head and shoulders pattern is the opposite of the head and shoulders pattern. It is also known as the reverse head and shoulders pattern. It has three valleys, with the middle (the head) being the lowest and the left and right valleys at a higher price. The reverse head and shoulders pattern typically shows that there is about to be a bullish reversal.

In this case, the neckline forms a price resistance, and a price breakout above the resistance is seen as an opportunity to buy, and the stop-loss is placed below the neckline.

5 Advantages of the Head and Shoulders Pattern

The following are some of the benefits of the head and shoulders pattern.

1. Easy to Spot: The head and shoulders candlestick pattern is easy to spot and interpret. In addition, it is beginner-friendly, making it easily accessible to traders of all levels of experience.
2. Provides Clear Entry and Exit Positions: The neckline breakout becomes a crucial level of resistance that triggers a sellers’ market, and you also can set your stop loss above it to close the trade in case it does not go in your favor.
3. Helps to Identify Key Price Levels: The head and shoulders pattern provides clear support and resistance areas for price. The neckline can function as resistance when the price breaks below it and as support when it rises above it. With this, traders easily identify different key levels on the chart.
4. Useful Across Different Timeframes: It’s useful for scalpers, day traders, swing traders, and position traders alike. The adaptability makes it easy to incorporate it into your trading strategy.
5. Provides a Good Ground for Trading Trend Reversal: You can use the head and shoulders pattern to trade trend reversals in the market. It gives a clear signal to sell cryptocurrencies, which can help you know the best time to sell your cryptocurrency in a bullish market.

3 Disadvantages of the Head and Shoulders Pattern

Here are some disadvantages of the head and shoulders candlestick pattern:

1. May Be Ineffective in Ranging Market: The head and shoulders pattern may not be effective when the market is range bound. In such a market, there can be a lot of fake breakouts. Since traders may not know when a consolidating market will end, the strategy may be ineffective and give various false signals.
2. Possible False Signals: Like any other technical analysis tool, the head and shoulders pattern can give false signals, and it is better to use it with other tools or at least manage your risks effectively when using it.
3. It May Be Confusing: While the head and shoulders pattern is considered a reliable reversal pattern, as was mentioned earlier, it can come in various structures, making it challenging for a beginner to notice. The neckline, for example, may not form a horizontal line, making it hard to know when it gets broken.

Always Take a Rounded Approach in Your Analysis

When trading the head and shoulders pattern or any other trading strategy, you should always remember that there is no strategy that always guarantees success. It is best to use a rounded approach in trading using technical, fundamental, and sentiment analysis for the best possible result.

​The information on this website does not constitute financial advice, investment advice, or trading advice, and should not be considered as such. MakeUseOf does not advise on any trading or investing matters and does not advise that any particular cryptocurrency should be bought or sold. Always conduct your own due diligence and consult a licensed financial adviser for investment advice.