Cryptocurrency fans on Twitter are frequently apt to see trading-pattern commentary. Among the more common patterns mentioned is the head and shoulders (H/S) pattern. Traders believe this pattern reliably indicates that a bearish trend is about to begin. As you can see below, this pattern begins with a small pricing peak and decline (the left shoulder); followed by a more substantial pricing peak and decline (the head), followed again by another small pricing peak and decline (the right shoulder). The line connecting the two price bottoms is called the neckline.
Similarly, a bottom H/S pattern can signal an upcoming bull trend. As this pattern is inverted, it displays three consecutive price dips rather than two (the middle price dip being the lowest). In this scenario, two price rallies exist before an ongoing one takes hold. For both top and bottom H/S patterns, price fluctuations reveal the waning momentum to sustain a current price trend.
Trading the Pattern
Trading patterns are remarkably easy to spot once they’re complete. However, assuming that such a pattern exists before it completes is fraught with peril. In an H/S top pattern, traders often wait until prices move lower than the neckline before trading. Conversely, traders witnessing an H/S bottom pattern often wait until prices move higher than the neckline before trading. Patience is a key element in successful trading. Rather than being impetuous, successful traders determine their profit targets and trading price points beforehand.
Learning how to carefully read H/S patterns isn’t terribly complicated. Knowing what to look for is helpful, however. For instance, an experienced trader would note the neckline’s slope between the two price dips as it showcases how bearish or bullish the market is (not an earth-shattering revelation but sometimes overlooked).
Moreover, traders can sometimes peg H/S patterns early on by noting their trading volume. An H/S top pattern will display heavy trading volume before the first price-dip, followed by notably less volume as the price struggles to reach its peak (the head). Once the price begins to fall, trading volume will dramatically rise as traders struggle to sell. Trading volume again increases when prices fall again after the last price peak (the right shoulder). Short-term traders do not want to be left ‘holding-the-bag’.
Determining Price Targets
After an H/S pattern completes, some traders will use the pattern to estimate a future price target. That’s because the vertical distance between the peak head and the neckline more or less mirrors the future price drop from the right-shoulder neckline after the H/S top pattern completes. Of course, traders may also use such measurements to gauge future bull-trend price targets as well (by measuring the price drop from the neckline can be used to set a future bull market target).
H/S patterns may not always develop as expected. Even textbook H/S patterns can be disrupted by sudden event (i.e., a hacking theft from a major exchange). Moreover, crypto fans must remember that individual cryptocurrency prices are heavily influenced by bitcoin. Still, H/S patterns are fascinating as they so clearly display market psychology at work. As one trading blog has stated, “..it isn’t the price structure itself that causes the market to reverse. It’s the transition that occurs between buyers and sellers. The pattern is just the outcome or byproduct of that process.”
The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.