Head and shoulders is a distant relative of triple top. Instead of having 3 tops at the same level, the formation of this pattern create a CLEARLY HIGHER peak (Head) in between of 2 other peaks (Shoulders), which are at a relatively same level. The neckline is also drawn by connecting 2 troughs of the pattern. A pullback is common. The completion of the pattern is marked when Price breaks through the neckline, which provides an opportunity to sell.
+ Stoploss level should be put right above the Head.
In this first example, we have a perfect Head and Shoulders pattern with a horizontal neckline and 2 shoulders at a relatively same level. In the next 2 more examples, you might notice that the pattern will not possess the perfection of the first example. However, it is more common to see an imperfect pattern.
Inverted head and shoulders creates a clearly lower trough in between of 2 other troughs, which are at a relatively same level. The neckline is drawn by connecting 2 peaks of the pattern. A throwback is common. . The completion of the pattern is marked when Price breaks through the neckline, which provides an opportunity to buy.
+ Stoploss level should be put right below the Head.
NOTE: There is another strategy to trade this pattern. Traders often try to catch the top of second shoulder by selling when the price reaches the same level of the first shoulder. And of course the stop loss will be set above the Head. This strategy has proven to be quite effective. However there are times when price just doesn’t break the neckline and create a symmetrical triangle (discussed next chapter). Hence, traders using this strategy should be aware of this situation and book some profit when price is approaching the neckline.
This strategy can be used with inverted Head and Shoulders as well.