In this article, we will cover
- What is a head and shoulders pattern?
- Components and psychology behind the formation of the head and shoulders pattern.
- How to trade using a head and shoulders pattern?
- Real-life examples of a head and shoulders pattern
What is a Head and Shoulders Pattern?
The head and shoulders pattern is a bearish reversal pattern. Now you must be wondering, what is a bearish reversal? A bearish reversal is an indicator that helps you predict that the share price might start falling. It occurs in an uptrend. A head and shoulder reversal pattern forms and if you see a confirmation, it is then said that there is going to be a bearish reversal. Take a look at the illustration below.To understand the head and shoulders pattern in detail watch the video.
Let’s now zoom into the highlighted section and look at the components of a head and shoulders pattern.The Components and Psychology Behind the Formation of Head and Shoulders Pattern
- A prior trend
- The reversal pattern
- Confirmation of the reversal
How to Trade Using Head and Shoulders Pattern?
- Measure the vertical price difference from the peak of the head to the neckline. In this case, the peak is Rs. 120 and the neckline is at Rs. 100. So, the difference is Rs. 20 (Rs. 120 - Rs. 100)
- From the neckline, deduct the difference amount. It will act as your target price. Here, the target price would be Rs. 80 (Rs. 100 - Rs. 80)
Real-life Examples of a Head and Shoulders Pattern
Head and Shoulders pattern formed in SBI
We can see the formation of a head and shoulders pattern in the chart of State Bank of India (SBI). The stock was in an uptrend and rallied from Rs. 378.15 to Rs. 418.15. After which we saw the formation of a head and shoulders pattern with the following details. Left shoulder = Rs. 434. 10 Head = Rs. 441.80Right shoulder = Rs. 435.65The vertical price difference between the neckline and the head was 22.85%. So, after confirmation, you could place a short trade with a target of Rs. 399. After a few days of the formation of the head and shoulders pattern, the stock hit a low of Rs. 402.95 which is close to our target price.Head and Shoulders pattern formed in Bajaj Finance Ltd.
We had seen a long bullish rally in Bajaj Finance from 16th August 2021 to 31st August 2021 from Rs. 6,115.80 to Rs. 7,608.60. Later, the stock took a small dip and bounced back to form the head and shoulders pattern. Left shoulder = Rs. 7,988.05Head = Rs. 8,037.80Right shoulder = Rs. 7,745.45The vertical price difference between the neckline and the head was 7.42%. So, after the stock broke the neckline you could enter into a trade with a target of Rs. 6,915.05. On 26th Nov 2021, the stock hit a low of Rs. 6,775.10. So, it surpassed our target price.Head and Shoulders pattern formed in Eicher Motors
From 31st August 2021 to 8th September 2021, the stock price of Eicher motors was in an up move. It rallied from Rs. 2,547.65 to Rs. 2,878.80. After a small dip, the head and shoulders pattern was formed. Left shoulder = Rs. 2,925.80Head = Rs. 2,979.70Right shoulder = Rs. 2,923.10The vertical price difference between the neckline and the head was 7.10%. So, after confirmation, you could enter into the trade with a target of Rs. 2,511.35. After a few days, the stock hit a low of Rs. 2,469.05 which was far below our target price.Bottom line
These were some real-life examples of the head and shoulders pattern. I hope you found this guide helpful. Learning about chart patterns will strengthen your base and unlock new doors to creating wealth in the stock markets. The head and shoulders pattern is indeed a popular reversal pattern. All you need to do is understand the psychology behind the formation of the pattern and enter with the right strategy. By doing so you can truly mint money from the markets. This was one chapter of technical analysis. But there is so much more to learn. Our Chief Market’s Editor, Apurva Sheth has created a playlist on the basics of technical analysis. Check it out by clicking here!To start trading open a FREE Demat account with Samco and apply your trading skills to make money from the stock markets.Happy trading
The author knows how to explain complicated parts of technical analysis in a simplified way. Best available guide on head and shoulders pattern. Kudos!