A Beginner’s Guide on Head and Shoulder Patterns in Crypto Trading
We are over a decade on now, and cryptocurrencies and blockchain technology are now entirely into the limelight. However, one thing that remains a puzzle to many is how to maneuver this attractive nightmare. First, blockchain technology presents itself as one complex technology whose features unlocked unprecedented capabilities across almost all sectors. Cryptocurrencies then take their place as a global topic for discussion as the digital assets carrying the potential for creating overnight dollar millionaires.
There’s, however, one major downside, volatility, which is why many people are still losing huge chunks of money even as others reap big from them. These expert traders rely heavily on charts for their technical analysis, and so we try to understand one of the common chart patterns, the head and shoulders pattern.
What are Head and Shoulder Patterns?
A head and shoulders pattern is usually a technical formation on cryptocurrency charts that signifies a trend reversal is near. The pattern is easy to identify on charts as it is typically a baseline with three consecutive peaks but of different heights. The middle peak is the highest and is referred to as the head, while the lower left and right peaks form the shoulders.
What Makes a Head and Shoulders Pattern?
Trading charts form different patterns, which all carry a vital message for crypto traders. Before you can trade, it is essential to understand the movements in terms of the shape and the reasons behind the rallies and lows. For instance, a deep understanding of the head and shoulders pattern would help you understand different actions and the trading decisions to make.
The head and shoulders pattern carries five attributes which start with an uptrend, left shoulder, head, right shoulder, and a neckline.
The uptrend is the very first sign of the beginning of a head and shoulders pattern. It is the earliest trend in the entire pattern, and traders may not essentially know what will follow. The price of the asset is usually rising until it gets to the point of exhaustion. Generally, if an uptrend lasts longer, traders should expect a massive reversal.
The Left Shoulder
After exhaustion, the prices start to fall and even go below to a new high low. The left shoulder is formed at this point, but traders still have to wait before determining a neckline.
The price starts to rise again from the new high low. It marks the beginning of a short bullish rally, where the price shoots to make a higher high which becomes the pattern’s head. The price then falls substantially and breaks the previous low. The new high low provides the basis for drawing the neckline and the beginning of a wave of a bullish rally to form the right shoulder.
The Right Shoulder
The beginning of the right shoulder makes everything clear about a head and shoulders pattern. It signifies that buyers are tired, and the market could be preparing for a reversal. Its beginning makes it possible to draw the neckline, although it would be best to take it as a rough draft since the pattern is yet to complete.
The prices rise steadily but do not break the preceding peak before they start to fall.
At this point, the pattern is complete, and the head and two shoulders are visible. It is the right time to draw the neckline support, a key element in trading breakouts. The neckline is usually marked by connecting the lowest points of the troughs.
Trading the Head and Shoulder Pattern
The best entry point for the head and shoulders pattern is when the price breaks the neckline support. Traders should have appropriate risk management strategies such as the stop-loss order. You can place the order just above the shoulder for a rising pattern and below the shoulder for the falling pattern. Traders can also make profit estimates by measuring the distance between the peak of the head and the highest low and subtracting the pattern’s height from the neckline breakout point.
Traders should, however, be aware that the head and shoulders pattern does not initially signify a bullish or bearish trend until the price breaks out. The price must break below the neckline and continue to fall to confirm a reversal. If the pattern forms but the price fails to break below the neckline and instead begins to rally, it indicates that the upward price trend continues.
The head and shoulders pattern could also form an inverted chart. The inverse head and shoulders pattern is usually an inverted normal pattern. It starts by creating a valley rather than a left shoulder, followed by an extended deeper valley, then another shallower valley. In the inverted pattern, traders would put a long entry order just above the neckline. The target profits are calculated by measuring the distance between the highs and lows, just like in the normal pattern. The inverted pattern is confirmed when the price breaks above the neckline and keeps rising.
From the explanation above, it is conclusive that the head and shoulder pattern could signify the end of a downward or an upward trend. Therefore, it would be best for traders to wait for the price breakout before making a move. Above all, traders should remember to use the neckline to know the time for an entry or exit and the right shoulder for stop-loss limit orders. The pattern’s height is the parameter for profit estimates, although this is simply an estimate.