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Technical analysts use a whole host of methods to find turning points in charts, be it through the use of indicators, patterns, or historical highs and lows.
However, while indicators are very popular, the use of patterns hold additional value given the direct relationship with the price. Such patterns will give you an idea of where the price could go next, while also providing crucial elements such as where to place your stop loss and targets.
What is the head and shoulders pattern?
One of the most popular patterns is the head and shoulders, which is commonly used to find market reversals. For a traditional head and shoulders formation, the pattern is created through the failure to create a new higher high, followed by the break below the prior swing low. The opposite is true for an inverse head and shoulders.
This usage of swing highs and swing lows to determine market direction also allows for the easy understanding of more complex head and shoulders formations.
Spotting the head and shoulders reversal pattern
For now, sticking with the traditional head and shoulders formation, the example below highlights its traditional form as a market top reversal pattern. This shift from the creation of higher highs and lows, to a scenario which ultimately resolves with lower highs and lows completes the reversal signal.
Utilising this shift in the sequence of highs and lows, traders will see a head and shoulders formation as a reversal pattern around which they can trade.