Head And Shoulders Chart Pattern – 3 Rules To Trade it Profitably.

This video on the Head And Shoulders Chart Pattern shows how to dramatically improve your win/loss ratio.

A Head And Shoulders Chart Pattern is not simply a higher high, followed by a lower high.

WRONG! That’s not enough to identify a profitable Head and Shoulders Pattern.

The best ones are also TRIANGLES at the same time! Oh, and there’s 2 other critical elements most traders are never taught.

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VIDEO TEXT:

Hey! Welcome to this video on the Head And Shoulders Chart Pattern, and you know, a lot of people trade this totally wrong. A lot of people over-simplify it, but I’m also going to show you how to trade the most effective patterns. What they look like and why. So, we give you the logic behind as well, so you can have confidence in it and understand that, ‘Oh this makes sense!’ So, here we go. Let’s look at a couple of things. There’s really 3 points in today’s video.

RULE #1

A real, true Head and Shoulders chart pattern is one that occurs at the end of a trend. because Head and Shoulders pattern is a trend reversal pattern. Sometimes I see people looking at things like that. They’ll actually see this as a left shoulder, and that as the head, and that as a right shoulder. That is absolutely not a Head and Shoulders pattern.

By the way, for those who maybe don’t know, a Head And Shoulders Chart Pattern basically looks like this: you have a high, then you retrace, a higher high, then a retrace, then a lower high and then a retrace. And people call these different things but basically Head and Shoulders pattern. That’s the basic idea. A high, a higher high and a lower high.

That’s an over-simplification and that’s the problem that a lot of amateur traders make, is they think that’s all it is. That’s the basic Meta pattern but there’s more to it. The reason that this, right here, does not qualify as a Head and Shoulders pattern is because a real Head And Shoulders Chart Pattern only occurs at the end of a trend. And we do not have an up-trend here. So, this would be…we’ve got a nice impulse move here, but really we’ve already had a major down move and this does not qualify as a trend moving up.

WHAT IS A TREND?

A ‘trend’ defined by Webster’s dictionary is the extended general direction of a move. So, think of that, extended, general. Long-term move, right? This is not a long-term move up. So, this is not Head and Shoulders pattern, and that’s why this does not go down and why it does not work because it’s not even a Head And Shoulders Chart Pattern to begin with.

RULE #2

The second point here is that here, we could look at potential Reverse Head and Shoulders chart pattern. There is your left shoulder, your head and the right shoulder. This is also a bad pattern. Now this one’s a little better than the other because at least, we are in a down trend, and it looks like it could be occurring at the end of the down trend, in order to then reverse the trend and go up. We’ve met rule one but we are violating rule two. What’s rule two? Well, let me show you.

The neckline goes from here to here. Okay, so left shoulder, head, right shoulder, and then this high and that high. Now, here’s the problem with this: so, this, if we draw a line horizontally across here, we’ll see that this right neckline broke the high of the left neckline. There’s actually some people who say that’s a good thing, and that those probabilities were the probabilities of that type of pattern is better than if the neckline stays below this neckline or in other words, the right neckline stays below the left neckline.

THE PROBLEM WITH BACK TESTING STATISTICS WHEN TRADING THE STOCK MARKET, FOREX AND E-MINIS.

Understand that a lot of statistics done on chart patterns are done on daily charts. Now, I showed the daily chart on the last chart. This one’s a little two-minute chart. You might think, ‘Well, do Head And Shoulders Chart PatternS actually work on a two-minute chart?’ Yes, they actually do – they do as long as there’s enough volume. This is the E-minis here and so, good volume, two-minute charts work fine.

But the statistics that work on a daily chart don’t necessarily work in an intraday chart, number 1. And number 2 just because something statistically had worked in the past does not mean it will in the future, and so be very leery of all those statistical analysis because well, you see it everywhere that you sign up for a brokerage firm software, whatever it says, ‘past performance is not indicative of the future results,’ so there you go, enough said.

Here is the problem with the logic of the above-mentioned pattern. We actually want the right neckline lower than the left neckline, and here is why: this might seem like, ‘Oh good, this is a confirmation that the move is strong – up.’ Well, as in most things with trading, by the time you get confirmation, the deal is done. I prefer to call trading ‘speculating,’ kind of an old term there from the days of yore, but I prefer to use it because it keeps reminding me that’s always very risky, that we’re managing risk.

PROFESSIONAL TRADERS GET IN EARLY, AMATEURS WAIT FOR TOO MUCH CONFIRMATION AND THUS GET INTO TRADES LATE.

So, traders – good traders – professional traders get in before things are confirmed, before things are obvious. Well, by the time this occurs, everybody sees it and therefore, the amateurs are getting in and it’s too late – you are too late to the party. You want to get in before things are confirmed and then you manage your money and risk, in case it doesn’t work out, and that’s professional trading.

So, if you look at this, okay, we break that high. Now, again the entry which we’ll get around trend point 3 is also a problem, with this…let’s just look into the future here a little bit. So, as you can see it didn’t really go very far.

The entry, the traditional entry is when it breaks this high, and if you took it when it broke that high, you get exactly what happens a lot these days which are failed breakouts. So, I would never want to enter above this high. Just way too late, that is amateur trading. So, let me show you how I trade these Head and Shoulder chart patterns that works out real well.

RULE #3

Here’s our 3rd principle, and let’s just review one and two first…and show you how it works here. So, we’ve got pretty good move down, it’s been moving down for quite a while, comes back up, so that’s our left shoulder, that’s our neckline, make a lower low. Now that’s our right neckline and that’s our right shoulder.

Now, we could enter, the break here, but as I said, I don’t like that but here’s the first thing that I want to point out: this pattern is two patterns in one. In other words, having the right neckline lower than the left neckline gives you two patterns in one. So, a lot of people are going to wait for this breakout here, or some people would do the trend-line and that’s actually a little bit better. I would prefer that. I’m not against trading the trend-line; that one’s okay. But waiting for up here, you’re really paying retail instead of buying wholesale.

TWO PATTERNS IN ONE!

But here’s what I want to point out about these patterns – two patterns in one. Look at this: so, if we connect these highs and we connect these lows, what do we got? We’ve got a triangle, a symmetrical triangle. And so when you get a Head and Shoulders pattern like this where the right neckline is lower than the left neckline, you have two patterns in one.

One, you’ve got the Head and Shoulders pattern, and two, you’ve a Triangle pattern. Triangle patterns are known for breaking out into fairly nice moves. At least, you get a usually good impulse move out of them because there are contraction that moves into expansion, and that’s a cycle in the market: expansion, contraction, expansion, contraction. So, we’re looking for a nice impulse move out of this which we get, and since we get a nice impulse move there, we get back into a little contraction, another impulse move there into back into little contraction. Normal – that’s what normally happens.

WHERE TO ENTER THE HEAD AND SHOULDERS CHART PATTERN?

Where do you get in? Okay. So, you’ve got a couple of options. Number one is you can trade the break of this trend-line. In this case, that option and the one I’m going to mention wouldn’t really make much difference.

If you have a timing tool, a cycle indicator, then you can actually trade this low right here, before the breakout, and that really gives you an incredibly low risk and then proportionally, higher risk-reward ratio. But you got to have a great timing-tool in order to do that.  So, if you don’t have that I’ll give you mine. Feel free to write me up at support@topdogtrading.com and I can make that available to you for free, and it works out in any charting platform.

ONE FINAL, BUT IMPORTANT POINT

And one last point that I, one last point that I mention about the Head And Shoulders Chart Pattern. For these to work out, what you want to see a shift of momentum. In other words, momentum can be stronger down here. I’d actually like to see momentum shift here where it’s maybe a little divergent but then for here and this right shoulder. I definitely want to see very little momentum going down.

Whatever momentum indicator you like to use, whatever is your favorite. I’ve done lessons on RSI, and MFI and all kinds of things like that, even the momentum indicator. But you definitely want to make sure there is a momentum shift here. So, that this move down here is a weakness and where our momentum is shifting back into a bullish territory.

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