TL;DR: Head and shoulders is a reversal pattern with three peaks: a left shoulder, a higher head and a lower right shoulder, with a neckline through the lows. Only a break below the neckline confirms the pattern. The inverse pattern (after a fall) is the mirror image. The pattern fails regularly.
What can you expect?
- Time per week
- About 3 to 6 hours a week for looking at charts, planning and reviewing.
- Starting capital
- No fixed minimum. With small amounts, order costs and spread weigh heavily. Only use money you can afford to lose, and never risk more per trade than you decided in advance.
- Typical setbacks
- False breaks, patterns that fail, strings of losing trades and gaps that run past your stop-loss. When going short, the price can rise sharply.
- Costs
- Order costs, spread, financing and overnight costs on CFDs, borrowing costs when shorting and possibly the cost of price data. Compare the costs of several brokers.
- Not suitable if…
- People who want to play it safe, cannot bear losses or have no experience with leverage and short selling. Beginners are better off practising in a demo first.
How it works
The head-and-shoulders pattern is a classic pattern in technical analysis. After a rise, the price forms a left shoulder (peak), a higher head and a lower right shoulder, with a support line (neckline) through the lows between them. If the price breaks below that neckline, the pattern points to a possible reversal. The inverse pattern after a fall points to a possible rise. The pattern is only confirmed by a break, and even then it can fail. A price target from the height of the pattern is a rule of thumb. This is education, not investment advice.
Core principles
- 1. The pattern needs a prior rise (the inverse pattern a fall)
- 2. The head is higher than both shoulders
- 3. Only a break of the neckline confirms the pattern
- 4. A break on higher volume is more convincing, but no guarantee
Step-by- step plan
- 1
Look for a prior rise
The pattern needs a rise to reverse. Look for a clear trend of several weeks to months. Without a trend, there is nothing to reverse.
- 2
Recognise the left shoulder and head
Mark the left shoulder and the higher head with the lows after them. Draw a provisional neckline through those two lows.
- 3
Check the right shoulder
The right shoulder is a lower peak that does not reach the head. Many traders check whether volume is lower there. See it as a candidate, not yet a signal.
- 4
Wait for the break and plan your trade
Only trade after a close below the neckline. Decide in advance your entry, stop-loss, price target and position size, and calculate the ratio between risk and reward. Going short adds risk.
- 5
Manage and review the trade
Stick to your stop-loss and your plan. Record the trade in a journal and, after costs, review which patterns worked and which did not.
In detail
Structure of the pattern
The pattern has four parts. The left shoulder is a peak followed by a fall. The head is a higher peak, followed by a fall to roughly the same level. The right shoulder is a lower peak that does not reach the head. The neckline joins the two lows and is seen as support.
If the price breaks below the neckline, the pattern points to a possible reversal of the rise. A neckline does not have to be horizontal. There are no fixed rules for how symmetrical the pattern must be.
The inverse pattern
The inverse head and shoulders is the mirror image after a fall: a left shoulder (low), a lower head and a higher right shoulder, with a neckline as resistance. If the price breaks above the neckline, that points to a possible rise. The price target is calculated the same way, but upwards. This pattern can also fail.
Price target and measured figures
The price target is the distance from the head to the neckline, measured from the neckline. That is a rule of thumb. Thomas Bulkowski has tracked the results of thousands of patterns. His figures for the head-and-shoulders top (see the source note for this pattern) show that the price target is reached in about half of cases. It is historical, measured against the price target, before costs and no guarantee for the future.
Volume, risk and short selling
Many traders look at volume: falling towards the right shoulder and higher at the break. That can help avoid weak patterns, but guarantees nothing.
If you trade a fall, you go short. That can be done via CFDs or options. The loss is theoretically unlimited if the price rises, and with leverage losses mount faster. Financing costs come on top. Use a stop-loss, limit your position size and practise in a demo first.
- Able to recognise trends, support and resistance
- Basic knowledge of stop-loss orders and short selling
- A fixed plan for risk per trade
- Charting package with volume
- Position-size tool
- Trading journal
- 01 Look for a complete pattern: left shoulder, head and right shoulder
- 02 Draw the neckline through the two lows
- 03 Only enter after a close below the neckline (above it for the inverse pattern)
- 04 Check whether volume at the break is above average
- 05 Calculate your risk and position size in advance
- 01 Place a stop-loss above the right shoulder (below it for the inverse pattern)
- 02 A common price target: the distance from head to neckline, measured from the neckline
- 03 You can close part of the position at an interim target
- 04 Close or review the position if the price goes back through the neckline
Figure in contextSource: Thomas Bulkowski, 'Bulkowski on Head-and-Shoulders Tops' on thepatternsite.com (based on his research for the Encyclopedia of Chart Patterns). In a bull market, 51% of patterns met the price target; the 'break-even failure rate' (his own definition of failure) was 19%. Historical, measured against the price target, before costs, no guarantee.
Worked example
Made-up worked example (not advice, not a forecast). A share rises and forms a head and shoulders. The head is at €100, the neckline at €85 and the right shoulder at €93. After a close below €85 you go short at €84.50. You set your stop-loss at €94 (above the right shoulder).
Formulas:
- Pattern height = head − neckline = €100 − €85 = €15
- Price target (rule of thumb) = neckline − height = €85 − €15 = €70
- Risk per share = stop − entry = €94 − €84.50 = €9.50
- Reward per share = entry − target = €84.50 − €70 = €14.50
- Reward / risk = €14.50 / €9.50 = 1.53
Position size: if you want to risk at most €100, that is €100 / €9.50 = 10.5, rounded down to 10 shares. A loss at the stop is 10 × €9.50 = €95. The target would yield 10 × €14.50 = €145, before costs.
The target is reached in about half of cases (see the source). When going short, financing and borrowing costs also run on, and on a gap the price can rise beyond your stop. These are made-up figures.
Hypothetical example, not advice.
Work it out yourself
Risks and risk management
- The pattern fails regularly: the price target is often not reached
- Patterns are easier to see in hindsight than in the moment
- False breaks and a quick return above the neckline
- Anyone betting on a fall (short selling) can face an unlimited loss if the price rises
- With leveraged products such as CFDs, losses can mount quickly and financing costs come on top
- Gaps and fast moves can run past your stop-loss
- Costs (spread, order costs) and borrowing costs when shorting
Learn the basics
Key takeaways
- Head and shoulders is a classic reversal pattern, but not a reliable predictor. It fails regularly.
- Only a break of the neckline confirms the pattern. Anyone trading earlier is trading on an expectation.
- The price target from the height of the pattern is not reached in a share of cases. So plan with a stop-loss.
- Going short carries extra risk. Limit your risk per trade and practise in a demo first.
Frequently asked questions
How often does the head-and-shoulders pattern work? +
There is no fixed percentage. Thomas Bulkowski found for the top pattern in his data that the price target was reached in about half of cases (see the source note). That is historical and before costs, and says nothing about what the next pattern will do. Treat every pattern as a candidate and limit your risk per trade.
Can I trade the pattern on a short timeframe? +
You can draw the pattern on any timeframe. On short timeframes there is more noise and false signals are more frequent, while costs such as spread weigh more. Beginners are better off practising first on longer timeframes and in a demo.
How do I recognise a real right shoulder? +
A right shoulder is a lower peak that does not reach the head, with a neckline running roughly through the lows. If the price rises above the head, the pattern has failed. You can only be sure afterwards, so wait until the pattern is complete and the neckline breaks before you trade.
Origin
General technique