How to Profit From the Head and Shoulders Pattern (And Avoid Common Mistakes)

head-and-shoulders-pattern

The head and shoulders pattern is by far my favorite way to trade reversals in the Forex market. They don’t come around often but when they do the profits can be considerable.

It isn’t abnormal to see moves of 500 pips or greater from these patterns. We’ll take a look at one that formed on the GBPJPY that resulted in a very profitable 1,800 pips.

But what actually qualifies as a head and shoulders? Where should it form on a chart and what attributes does it need to have?

Exclusive Bonus: Download the Head and Shoulders PDF Cheat Sheet that will show you everything you need to know to make money from this reversal pattern.

Then there are the questions about entries, exits and of course the often-confusing measured objective. All of these unknowns can lead to an endless stream of confusion.

If you find yourself asking these same questions, then you’re in luck.

By the time you finish this lesson, you will know how to identify the very best reversals and how to enter and exit for a profit. I’ll even show you how to determine a measured objective so you can squeeze out as much profit as possible while managing your risk.

Let’s begin.

Key Attributes of the Head and Shoulders Pattern

Before you can trade it, you must first know the key attributes of the pattern. That way you can easily spot the most favorable head and shoulders to trade.

Let’s start with the illustration below.

head-and-shoulders-pattern

As you can see from the drawing above, the head and shoulders pattern has five attributes.

In order of occurrence, they are:

  1. Uptrend
  2. Left shoulder
  3. Head
  4. Right shoulder
  5. Neckline

Notice that I placed the “neckline” last. At first, that may seem like a mistake.

However, we need both shoulders and the head of the pattern before we can identify the neckline. If that sounds confusing, don’t worry. It will make more sense as you progress through the lesson.

Now let’s discuss each step in greater detail.

Step 1: Uptrend

The very first part of a head and shoulders pattern is the uptrend. This is the extended move higher that eventually leads to exhaustion.

As a general rule, the longer the uptrend lasts, the more substantial the reversal is likely to be.

Step 2: Left shoulder

The market moves down to form a higher low. At this point, things are starting to come together, but we don’t quite have enough to draw the neckline.

Step 3: Head

Now that the left shoulder has formed, the market makes a higher high which forms the head. But despite the bullish rally, buyers are unable to make a substantially higher low.

At this point, we have the left shoulder and the head of the structure. The neckline is also beginning to take shape, but we need the right shoulder before we can draw the neckline on our chart.

Step 4: Right shoulder

The right shoulder is where things come together. It’s an indication that buyers are tiring and that the market may be gearing up for a reversal.

As soon as the right shoulder begins, we have enough to start plotting the neckline. But because the pattern isn’t yet complete, it’s best to think of it as a rough draft rather than a final version.

Step 5: Neckline

Now that we have a defined head and two shoulders we can draw neckline support. This level will become a key component when we get into how to trade the breakout.

Think of the neckline as the line in the sand between buyers and sellers.

What Is It and Why Does It Form?

All price action carries with it a message. Some messages are easier to read than others, but they’re always present.

Concerning the head and shoulders pattern, the message is that buyers are tiring and that you’d best prepare for a potential reversal.

But what is it about the pattern that causes the market to reverse? How can a few simple swing highs accomplish this?

These are the kind of questions that will help you unlock the clues and take you to the next level.

But there’s a problem…

The way I phrased the two questions above fails to capture the essence of the head and shoulders pattern.

You see, it isn’t the price structure itself that causes the market to reverse. It’s the transition that occurs between buyers and sellers. The pattern is just the outcome or byproduct of that process.

To better explain things let’s look at it from a different perspective. For this, we’re going to use a real head and shoulders formation that occurred on the GBPJPY weekly chart.

gbpjpy-head-and-shoulders-reversal

Notice how after carving out a higher high (head) and pulling back, buyers were unable to push the price back above the head. This eventually formed the right shoulder.

The lower high would be a big red flag if you were a GBPJPY bull during this time.

Let’s take another look at the same GBPJPY chart.

gbpjpy-highs-and-lows

If you’ll remember from the lesson on how to determine trend strength, the telltale sign of an impending trend change is a shift in the sequence of highs and lows.

For example, a market that’s been carving out higher highs and higher lows may be in trouble with a single lower high.

However, a trend is not technically broken until we get a lower high and a lower low. Note how the price action inside the second red circle above took out the last swing low.

As soon as that low was taken out, the GBPJPY signaled that buyers were in trouble.

The head and shoulders reversal doesn’t work because of the pattern itself. It works because of the way in which the highs and lows develop and interact with each other at the top of an uptrend.

Always remember to keep it simple. All we’re doing here is identifying a potential shift in trend by focusing on the relationship between highs and lows.

Head and Shoulders Breakout

One important thing to keep in mind about the head and shoulders pattern is that it’s only confirmed on a break of neckline support.

And by break, I mean a close below it.

A common mistake among Forex traders is to assume the pattern is complete once the right shoulder forms.

In fact, it’s only complete and thus tradeable once the market closes below the neckline.

head-and-shoulders-breakout

Notice in the illustration above that the market has closed below the neckline. This confirms the head and shoulders pattern and also signals a breakout.

Pro Tip: If you are on the daily chart, you would want to wait for a daily close below the neckline before considering an entry.

Now let’s go back to our GBPJPY example to see where the pattern was confirmed.

gbpjpy-confirmed-reversal

Notice how it took a daily close below neckline support to constitute a confirmed break. While there were a few previous sessions that came close to breaking the level, they never actually closed below support.

Next, we’ll discuss a few entry methods for trading the head and shoulders.

How to Enter a Break of Neckline Support

So far in this lesson, we have covered the five attributes of a head and shoulders pattern. We have also discussed how to differentiate a formation that’s still intact versus one that has broken down.

Now for the really fun part – how to trade and of course profit from a head and shoulders reversal.

There are two schools of thought on how to enter a breakout. The first is to use a pending order to go short just below the neckline. Note that those who use this method are not waiting for the market to close below the neckline.

The problem with this approach is that you leave yourself exposed to the possibility of a false break. You’ll often see a pair dip below support on an intraday basis only to close back above the level before 5 pm EST.

Which brings us to the second approach, and the one I prefer. This method involves waiting for a daily close below the neckline before considering an entry.

By doing this, you mitigate the risk of having the market snap back on your position and stop you out for a loss.

Because of this, we’re only going to focus on the second approach. But even when waiting for the market to close below the neckline there are two entry methods to consider.

Let’s discuss each in detail.

Entry Method #1

The first way to enter a head and shoulders break is to sell as soon as the candle closes below support.

For example, because we’re analyzing the GBPJPY on the daily time frame, we’d wait for a daily close below the neckline. That would be our signal to go short (sell).

Here’s how that would look:

Enter on close below neckline

Notice how we’re entering short as soon as the pair closes below neckline support.

Entry Method #2

While the method above has its uses, I usually prefer to wait for a retest of the neckline as new resistance.

This brings us to the second entry method.

Enter on retest as new resistance

Notice how with the second entry method we’re waiting for a retest of the neckline as new resistance.

This accomplishes two things:

  1. It helps validate the recent break
  2. It offers a more favorable risk to reward ratio

This combination is why I almost always opt for the second method. There is, of course, a greater chance of missing an entry by waiting, but the potential reward for doing so is equally great.

Stop Loss Placement and Risk Control

Despite being straightforward, the stop loss placement when trading the head and shoulders is a controversial topic. Some traders prefer a stop above the right shoulder whereas others choose a more aggressive placement.

Like everything you do in the Forex market, it comes down to what works best for you.

With that said, I tend to believe that a stop loss above the right shoulder is excessive. It unnecessarily and adversely affects your risk to reward ratio.

Here’s why…

A head and shoulders is confirmed with a close below the neckline, right? So a close back above that same level would negate the pattern.

Now, assuming my stop is above the right shoulder, am I going to wait for the market to take me out if it closes back above the neckline?

Of course not.

So really there are three ways to exit the trade should things turn sour. Let’s start with the first and, in my opinion, less appealing way and then we’ll finish up with my two favorites.

Stop Loss Placement #1

The first area you can place your stop loss is above the right shoulder.

Stop loss placement1

Notice how this option provides an ample amount of space between your entry and stop loss.

However, this isn’t necessarily a good thing. I’d even argue that it does more harm than good. You see, a stop loss that high means you’ve also cut your potential profit in half or worse.

In the case of the GBPJPY pattern the measured objective, which we’ll get to next, is 1,800 pips below the breakout point. If you chose this first option to set your risk, it means you’d have a 500 pip stop. If we divide that into the objective, we get 3.6R.

That’s pretty good but let’s see what we could have had using the section option.

Stop Loss Placement #2

This is my preferred stop loss placement. It allows for a much better risk to reward ratio while still affording me the ability to “hide” my stop.

Here’s how it looks on the GBPJPY chart:

Stop loss placement2

Note that I’m placing the stop above the last swing high. This is still about 200 pips from my entry, so it’s hidden, but it isn’t so far away that it adversely impacts my potential reward.

You can always go tighter if you’d like as it all depends on what fits your trading style. Just remember that the closer your stop loss is to your entry the greater the chance of being taken out of the trade prematurely.

Remember the 3.6R profit with the first stop loss placement above?

By setting your stop above the last swing high instead, you’ve cut your stop loss distance from 500 pips down to 200 pips. With an 1,800 pip objective, that’s an incredibly profitable 9R.

To put it in hypothetical terms, that’s a 7.2% profit versus an 18% profit, assuming you risked 2% of your account balance on the trade.

Exit on Close (Safety Net)

I call this my safety net. Because any daily close back above the neckline suggests invalidation. And I don’t know about you, but I’d rather take a 50 pip loss than a 100 pip loss.

Referring to the GBPJPY example above, if the market had closed back above the neckline after it closed below it, we would want to exit the trade. Such a close would signal that the pattern is no longer valid and that sellers are no longer in control.

In fact, this notion can be applied to just about any pattern you trade. It can help reduce the size of a loss in the event the market turns against you.

Profit Targets and Measured Objectives

Knowing when to take profit can mean the difference between a winning trade and a losing one. It’s arguably the most challenging aspect of trading.

When it comes to the head and shoulders pattern, there are two ways to approach it. And for some, a blend of the two may be the way to go.

Approach #1

The first and more conservative approach is to book profit at the first key support level. These are the areas you’ve defined that could cause the market to bounce. As such, it may be a good idea to take profit on a retest of one of these areas.

Because every situation is different, these support levels will vary. But the one thing that must always be true is a favorable risk to reward ratio. So always be sure to do the math before taking the trade.

Approach #2

The second and more aggressive approach is to use a measured objective.

Although using a measured objective is more aggressive as your target is further away from your entry, it’s also more universal.

Why is that, you ask?

When you use this method, you’re taking a measurement of the height of the entire pattern. So regardless of the situation, you will always have a specific target area.

Here’s one taken from the EURCAD daily chart:

Measured objective

Note that I measure from the top of the head directly below to the neckline. I then take that same distance and measure lower from the breakout point.

Measuring from this point is a small but significant detail, especially for necklines that develop at an angle.

One last note about measured objectives. Although they can be extremely accurate, they are rarely perfect. So as an added layer of defense, it’s best to think of them as general areas rather than specific levels.

Also, try to find a key support level that intersects with or at least comes close to the measured objective. This will help you validate the target area and give you a greater degree of confidence during the trade.

A Few More Examples and Explanations

Who doesn’t like more examples? I know I do.

So to start wrapping things up, here are a couple more examples of the head and shoulders in action.

Be sure to take note how each structure forms in its own unique way yet is still highly effective at signaling a reversal.

First up is the EURCAD daily chart.

eurcad-head-and-shoulders

Notice how in this case the measured objective lined up with a key pivot area. While it’s not required, this can add a greater degree of confidence to any trade idea resulting from the reversal.

The second reversal pattern formed on the USDJPY weekly time frame after a multi-year uptrend.

usdjpy-reversal-pattern

A significant difference here from the first EURCAD reversal is that the USDJPY neckline is a horizontal level. This is perfectly acceptable but isn’t very common.

In most cases, the neckline support will form at a diagonal. The pitch of the level can vary, but one thing must always be true – the level should move from lower left to upper right. Note the angle on the first EURCAD chart above.

Putting It All Together

Now let’s put everything you just learned together. The video below will walk you through the same EURCAD head and shoulders from start to finish.

 

A Few Key Insights Before You Go...

So by this point, you’re familiar with the attributes of the pattern, where to find it and most importantly, how to enter and exit for profit.

But there are a few key insights I want to share with you before you go. Think of these as rules to follow when trading the head and shoulders pattern.

Let’s get started.

The pattern must form after an extended move higher

This rule is self-explanatory. It can only be a bearish reversal pattern if it forms after an extended move higher.

One way to double check is to make sure there are no immediate swing highs to the left of the formation.

Take a look at the charts above. Notice all the white space to the left. That’s what you want to see when trading any bearish reversal pattern.

Neither shoulder can be above the head

You can’t raise your shoulders above your head, right?

For your sake, I hope not.

The same applies to this technical pattern. The head should always stick out above both the left and right shoulders. And while there’s no exact rule for the distance, it should be evident from a quick glance.

Pro Tip: If you have to question the validity of a pattern, it probably isn’t worth the risk.

The neckline should be horizontal or ascending but never descending

If you find a head and shoulders where the neckline moves from the top left to the bottom right, you may want to stay on the sidelines.

For example, if you see this:

Weak head and shoulders

It’s a sign of a “weak” reversal pattern. And while you may still enjoy a favorable outcome, the odds aren’t in your favor.

Instead, this is what you want to see:

Healthy head and shoulders

Note how the neckline is moving from lower left to upper right. This suggests a “healthy” head and shoulders pattern and one you probably want to keep an eye on.

In my experience, the steeper the angle of the neckline, the more aggressive the breakout and reversal is likely to be. Look no further than the GBPJPY example above.

The shoulders should be on the same horizontal plan

This one is a bit tricky to explain, so an illustration seems more appropriate.

Head and shoulders overlap

Notice how both the left and right shoulder “overlap” to some degree. Each shares a portion of the same horizontal plane. They don’t need to overlap entirely, but they do need to share a portion of the highlighted area above.

If you find a price structure that doesn’t fit this description, it isn’t technically a head and shoulders.

Stick to the daily and weekly time frames

Last but certainly not least are the time frames that tend to perform the best. After several years of trading these reversals, I can say with certainty that they are most reliable on the daily and weekly time frames.

While you can trade them on say a 1-hour or 4-hour chart, you run the risk of finding a lot of false positives. That is a pattern that looks like a head and shoulders but doesn’t perform like one.

To avoid this be sure to stick to the daily time frame and higher. After all, that’s where you can usually find the most consistent trends.

Final Words

There are many different ways to trade reversals in the Forex market, but few are as consistently profitable as the head and shoulders.

It isn’t just about trading a technical formation. It’s about “reading” the price action to understand the fundamental shift between buyers and sellers.

While there are no guarantees in the Forex market, the head and shoulders strategy you just learned is as close as it gets. Follow the guidelines above, and you’ll be well on your way to achieving consistent profits.

Now It's Your Turn...

Are you ready to start trading the head and shoulders reversal pattern?

If so, you definitely want to download the free head and shoulders pattern PDF that I just created.

It contains everything you need to know to maximize profits and minimize losses while trading them. That includes how to enter, where to place your stop loss, measured objectives and much more.

Click the link below and enter your email to get instant access to the cheat sheet.

Image for head and shoulders content upgrade

Leave a Comment:

44 comments
Gcinumuzi P Ngwenya says

This was very helpful and insightful Justin. How much is your mentorship?

Reply
Dale Moore says

This was great. Thanks. dale

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KOnrad says

Justin, It is very good and practical description what H&S is. Thank you.

Reply
Vijaykumar says

Hi Justin,
I Found This Lesson Helpful.
In Addition To The Points You Mentioned In The Lesson I Also Consider Below Mentioned Points While Trading H & S Pattern.
1. The Left Shoulder Have To Be Above The Up-Trendline.
2. The Volume Traded In The Head Area Should Be Relatively Lower Compared To The Left Shoulder.
3. The Candlestick Which Break The Neckline Should Have Higher Traded Volume.
4. The Bigger The Breakout Candlestick, The Better.
5. Stop Loss Placement #3 Would Be Above The High Of The Breakout Candlestick.

Let Me Hear Your Thoughts.

Thank You.

Reply
malcolm says

hi justin another great training thankyou malcolm ps dose it also work on a down trending market.

Reply
    Justin Bennett says

    Malcolm, you’re welcome. Yes, that’s the inverse head and shoulders. I’ll be writing a separate lesson for that.

    Reply
Solaron says

Thanks for a clear and methodical lesson on H&S. Are there any Head & Shoulder patterns forming now that I can keep track of. Solaron

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mirza akhtar mahmood says

wonderful, as always. thanks

Reply
Mohd Yazel Sabiai says

Great!!! Very helpfull… Thanks Justin…..

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Andile says

Thanks that was a helpful lessons

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Preeda says

Very useful content Thank U

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Juan says

Outstanding…I love your work Justin!

Thank you a lot.

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Zahra says

Hi Justin

I must say I’m really enjoying your material, I’ve just got your pin bar course and already I’ve learnt a few more things i didnt know before. With reading your head and shoulders pattern, i actually wanted to ask your opinion if that is the case in NZD/USD, on the daily time frame?

It appears that it has broken the neckline and currently as of today retesting the neckline, so in fact if it is – this would be an excellent opportunity to short it?

I would really appreciate the feedback as I havent signed up for the membership to have access to you as yet 🙂

Reply
    Justin Bennett says

    Hi Zahra, it did appear to be a head and shoulders, but the pattern was invalidated at the end of last month. Hope that helps.

    Reply
danilo says

Thanks that’s great
Must I wait for my stop loss to be hit or as soon as I identify a close above neck line I can close the trade???

Reply
    Justin Bennett says

    Danilo, you’re welcome. If it’s a daily close back above the neckline you’re probably better off closing the trade. No sense in losing additional capital if the market has invalidated the setup.

    Of course, that assumes that the neckline you’ve drawn is accurate.

    Reply
Imran says

I love the way you elaborate it. it’s a good article and really helpful.

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MATEYE SERATHA says

This article is very informative. Please provide a PDF file of it, like you did with the other patterns. So we can download it and print it out. Thank you in advance Sir

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Rick Stegen says

Very good and clear lessons Justin —Thanks

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Peter Bløcher says

Dear Justin!
Easy and understandable even for a Dane. Your videos help keep things connected.
The best greetings,
Blob

Reply
Lubabalo Chubeka says

Hi Justin. Thank you for the lovely lessons. I would like to know how do you draw the neckline, do you draw it to touch the lows of the candles on the left sholder or the daily close ?

Thank you!

Reply
    Justin Bennett says

    You’re welcome, Lubabalo. I usually draw them from the lows, that way I know I’m not missing anything.

    Reply
Alexandre Ribeiro says

Justing is it necessary that the right shoulder be a lower high to be head and shoulders?I see that the grapH USDJPY the right shoulder is higher than left should but in other graphs that you give as examples is a lower high!can you clarify that!
thanks a lot Alex

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Ntokozo says

I just love the way you elaborated the head and shoulders patterns, guess what, I just traded one on my market and I went short from right shoulder’s pick and exited at the first support since the neck was a descending one. I’m just waiting for daily close then enter again.

Reply
Hung Dang says

Thank you. Its very useful.

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Nickie says

I have been going through your lessons all weekend and have found them to be more informative than anything I have learnt in the last few months that I have been learning forex. Thank you so much.

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Euphemia Nwachukwu says

Hi Justin,

thanks for this clear explanations on HEAD AND SHOULDER PATTERN.
Actually I am new to your community. I have been trading currencies not quite long , I never liked
strategy because of the way other out there explains it , it looks so confusing to me, so i do not look at it all, but with the way you explained it , it is so clear and understandable to me now.

Please if a level is broken, is it a must for price to retest that level before continuing in its direction?

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Peter says

Nice teaching God bless you

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Caleb says

Thanks the session made it clear on the neckline and entry positions. I took the trade I made money then re-entered after the non-farm results I lost all I made .

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