MARKET ANALYSIS FOR NOOBS!!! PART 3 - CHART PATTERNS (HEAD & SHOULDERS)

What is a chart pattern?

There are millions or gazillions of traders making millions or trillions of trades every day and it is impossible to decipher the motivation behind stock price action. So chart pattern provide a convenient tool to identify the trading signal, and a peek at the trail of future price movement.

In previous section, I mentioned in the first post about the 3 assumptions that each techincal analyst has :
https://steemit.com/trading/@tngflx/trading-for-noobs-part-1

One of the assumption is that history tend to repeat itself. There's certain patterns can be seen thousands and thousands of times, unchanged from history. And they have high probability to behave in certain way. That's how chartists look for these opportunities and throw themselves into the pool of profit.

There are two types of pattern mainly : REVERSAL and CONTINUATION

Continuation pattern : When such pattern occurs, they will continue such trend in the future.
Reversal pattern : When such pattern occurs, the trend will discontinue and go the opposite way in the future

Pattern #1: Head and shoulders

Head and shoulders is a sign of reversal after an uptrend. It consists of 3 consecutive peaks, the middle peak being the highest HEAD, the two other peak being the shoulders. For each low of the peak, it will touch the baseline of support or resistance and this we call it the NECKLINE. If you didn't know what is support and resistance, do refer to the link I attached above. When the price trend moves below the neckline, it signifies a reversal of trend.

Breaking down the pattern

1. Prior trend :
   As you can see in the figure, prior trend is an uptrend. This is crucial to determine the existence of a head and shoulder pattern

2. Left shoulder :
   The price action continues on and reach a peak, but later declined to a certain low. But this low will not exceed the support line and still maintains its uptrend.

3. Head :
   Once again, the price action reached for the highest price among all the 3 peaks and coming down once again but still maintain above the baseline of support.

4. Right shoulder :
   The same as left shoulder. But this time the price action break below the baseline and enters into bearish trend. Right shoulder formed is because people are rushing in to buy after they lost the opportunity to ride to the head. So they thought this is the time to buy in again. But they're wrong. So now they're facing large selling and being force to sell their position.

5. Volume :
   Volume can be used as a secondary indicator mostly to confirm the bearish sign after the right shoulder. Sell volume should be really high as shown in the figure below. Typically, volume during the advance of left shoulder should be higher than the marching towards the head. When volume slowly decreases, it will form another trough or low.

So how should you trade?

Basically the safest way, is to wait until the pattern fully formed and trade right after the price action broke the neckline. This bearish sign is the entry point for sellers. This is the time you should take a profit and leave the bearish market. So it is wise to always put your stop above the neckline to take your profit.

What if it's an inverse head and shoulders?

Again the same thing, a buyer should wait until the price action near the neckline. Aggressive buyer may buy at the first sign of breakout. This of course come with great risk. The wiser thing to do is to wait for confirmation of the breakout. Conservative investor can trade right above the neckline. Stop loss order can be placed below the breakout price for aggressive investor. While conservative investor can place stop loss order below the right shoulder.

IMG SRC : https://tradingstrategyguides.com/head-and-shoulders-price-pattern-strategy/

CONCLUSIONS:

The pitfalls of this method of trading is that you have wait for a long time for formation of such pattern. The system is not perfect of course, but it does provide a trading method to all the investors out there and it's all based on market psychology and logical deductions. By this, I wish you benefit much from my article and improve more on your trading skills :)

SUMMARY IN A VIDEO :

Credit to Sasha Evdakov

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