Head and Shoulders Formation Explained

by | Aug 3, 2021 | Blog

A head and shoulders formation is a technical analysis pattern which signals a market reversal from bullish to bearish. It is considered among the most reliable signals in crypto trading. In this article, we are going to assume that you already know and understand how to read a cryptocurrency candlestick chart.

What is a Head and Shoulders pattern?

A head and shoulders pattern is formed after an upward trend. It starts by coming to a peak before dipping back down to the base of the prior upward move. Next, the price rises to a new level, higher than the first peak. This second peak is the “head”, while the first peak is the left shoulder. Next, there is another decline which creates another trough before rising back up to the level of the first shoulder. Finally, the asset’s value will start to decline as the market is now bearish.

Trading a head and shoulders pattern in crypto

If a clear head and shoulders pattern is recognised, it is not advisable to invest more into the asset. It is very likely that a downtrend will follow as this pattern is considered very reliable. To avoid falsely identifying a head and shoulders pattern, it’s important to remember that the left and right peaks (or “shoulders”) should plateau at roughly the same level whereas the middle peak (or “head”) will have a noticeably higher level.



Is there a Bullish alternative to this signal?

In a downward trend, it’s possible to identify the exact same pattern as a head and shoulders, only upside-down. This is known as an inverse head and shoulders (or head and shoulders bottom) and signals a trend reversal from bearish to bullish. The initial trough created where the declining price starts to rise forms the first shoulder before rising slightly. There is then a further drop in the asset’s price to a value lower than the first shoulder, this is the head. Finally, the value increases temporarily before dipping back to the level of the left shoulder, thus forming the right shoulder. This pattern typically signifies that the trend will reverse and implies a bullish period.

Inverse Head and Shoulders in Bitcoin Trading

As is true with a head and shoulders formation, an inverse head and shoulders is considered a reliable technical analysis pattern. It’s important that the “head” has a lower level than the “shoulders” to differentiate between an inverse head and shoulders and a simple period of consolidation.

In summary

As always in cryptocurrency trading, it’s important to use technical analysis methods in conjunction with one another. To rely on one signal alone is risky so we don’t recommend it. In saying that, a head and shoulders pattern has proven to be one of the most reliable signals along with a Bull Flag and a handful of others. It’s worth remembering the anatomy of a head and shoulders pattern so that you can act on it by your own technical analysis rather than relying on the signals of other traders. Having all these tools in your arsenal will only make you a better trader.


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