Trend Reversal Patterns - Head and Shoulders Pattern

Currency movements occurring on Forex are captured and translated by means of charts and other tools. The collected information is going to be analyzed technically and enframed within a certain pattern. Traders strategically plan their next move on the currency market basing their decisions on results derived from charts. The formations of such charts are selected according to their relevance and significance to the current trend of the currency that underlies it. The end of a trend is signaled by means of formations known as reversal patterns. An underlying currency trend is confirmed to be intact through chart formations called continuation patterns.

The article will restrict itself to a more general presentation of trend reversal patterns. The most significant types of such category of patterns are:
  1. head-and-shoulders and inverse head-and-shoulders;
  2. double tops and double bottoms;
  3. triple tops and triple bottoms.
In the following lines, the text is going to linger around the first reversal pattern, that is the one named head-and-shoulders. It is one of the most trustworthy and reliable chart formations. It is made of three consecutive rallies. The first and the last rallies (called shoulders) are of the about same height, whereas the second rally is the highest and is known as the head. The same support line serves as the basis of all three rallies and it is named the neckline.

The neckline is studied within several points, out of which the first is called the starting point. Prior to the earlier mentioned one, the neckline is a resistance line. The breaking of a resistance line results in the emergence of a significant support line. The points that follow the starting one study and render the bounce movements of price. Under a heavy volume, the neckline is broken and, consequently, the trend reversal is confirmed. The retesting of the neckline is done by means of a retracement, with the condition that the support line is broken.

The head-and-shoulders formation is useful as it generates important signals for traders. One such formation provides the following information:
  • the support line;
  • the resistance line;
  • the price direction;
  • the price target.
In a trending environment, in contrast, we want the market to give us more of an indication that it is turning rather than just a pause in support or resistance. In a strong trending market it is best to pass on counter trending signals unless you have the time and skill to trade on a lower time frame.