Crypto Trading Tips: Head and Shoulders Trading Patterns Explained
In this article we explain the head and shoulders patterns in cryptocurrency trading and how they indicate trend reversals.
One of the most reliable trading patterns used when conducting technical analysis, is the head and shoulders pattern. The head and shoulders formation signals either a bullish or bearish trend reversal, depending on the type of pattern. There are two types we will take a look at in this article. Head and shoulder top and head and shoulder bottom (inverse head and shoulder pattern). Two terms to know for this article:
Bulls = People who believe the price will go up and/or create positive price momentum upwards
Bears = People who believe the price will go down and/or create negative price momentum downwards
Head and shoulder patterns typically occur after a bullish upward trend and are commonly used to signal a trend reversal toward the downside when the formation is completed, in other words, it is a bullish to bearish trend reversal indicator. There are 3 main parts to the creation of a head and shoulder pattern:
- A bullish uptrend, where prices rise, peak, and fall to create a trough, or initial support level. (This creates the first shoulder and the support level will indicate the start of the neckline)
- Another stronger bullish uptrend occurs, causing prices to rise even higher than they did previously in step 1. This causes a higher peak, and another price decline to create another trough close to the first support level in step 1 (This creates the head and the support level will indicate the 2nd point of the neckline).
- Another mildly bullish uptrend occurs that peaks around the same level as step 1, then declines significantly, well below the neck line that was created.
The line that is running across the bottom by the support levels is indicative of the neck line. In the real world, these patterns may not look as neat and symmetrical as you see here. One shoulder may be higher than the other and the neckline may be slanted (sloped). A downward sloping neckline usually provides more confidence and stronger confirmation that the bullish trend is reversing and we are about to entering a strong bearish trend.
An inverse head and shoulder pattern, or head and shoulder bottom, signals a bearish to bullish trend reversal and indicates when a cryptocurrency is about to become bullish and trend upwards.
- A bearish downtrend, where prices fall to a trough, and then rise to reach a high and create a resistance level (This creates the first shoulder and the indicates the start of the neckline).
- Stronger bearish trend, price falls even lower to create a trough and then bounces back to reach roughly the previous resistance level as in step 1 (This creates the head and 2nd point of the neck line/resistance line)
- Another mildly bearish downtrend occurs, prices fall a little bit, similar to step 1, (This creates the 2nd shoulder). Once the prices break through the resistance level on its way up, it signals that the market is now in a bullish trend and will reach a higher high than the established resistance level.
Once the inverse head and shoulder pattern is complete, you will see significant trading volume when the neckline is broken on the upside. The market sees this as bullish signal and will jump to get into the cryptocurrency to ride the uptrend.
Head and shoulders is one of the more common and reliable trading patterns for different asset classes, including cryptocurrencies. It signals a constant battle between bulls and bears. In an inverse head and shoulder, the bulls ultimately win when the price breaks above the neckline/resistance level and continues on the upside as bulls and positive momentum carry the cryptocurrency upward. The opposite is true for a head and shoulder pattern. As it breaks below the neckline/support level, the bears win and the downward pressure ensues.
In both cases, the neckline or support and resistance levels are the key indicators for the trend reversal, so pay close to attention to when the neckline is broken in either case, and you see a spike in volume.
Disclaimer: Nothing in this article is to be construed as investment advice. Neither the author nor the publication takes any responsibility or liability for any investments, profits or losses you may incur as a result of this information.