Get head and shoulders above the rest: your crypto trading pattern #4
Part four of our mini-series sees us look at the Head and Shoulders pattern.
This is a pattern that I normally look out for on the lower timeframes (hourly and less) and to date, it’s certainly proved profitable in cryptocurrency trading.
How to get ahead
Those with a trained eye will note that from time to time, a Pinbar candle on a higher timeframe may sometimes appear as a Head and Shoulders on timeframes lower than where the Pinbar appears.
This is important to remember, as the Head and Shoulders pattern (just like the Pinbar) allows you to avoid getting into trades where the preceding trend may be coming to an end, with traders who aren’t aware of that, entering and becoming trapped.
Noticing and trading the Head and Shoulders pattern also allows you to enter the beginning of a new trend at such a great place that you are able to clearly define risk, enabling you to press your advantage hard against trapped traders.
The Head and Shoulders is more of an art form when it comes to noticing it in the charts…
The first thing I always look out for is a rally into a new area, or an area where price hasn’t traded for quite some time. You’ll see in the example below, price trades above prior highs and forms a head and shoulders pattern – head above the left shoulder and right shoulder below the head.
A key component of this pattern is the “neckline.” This neckline has to be a clear area where price has bounced off of and formed some sort of support, before then forming the right shoulder of the pattern.
Entry into this pattern comes only when the neckline has been broken by a thrust candle.
This candle has to 1) be quite aggressive in its nature in comparison to those around it and 2) close below the neckline. The aggressiveness of the candle is important as it shows a willingness for traders who have been caught long, to get out of their positions and exit quickly! The close below the neckline shows that value is now accepted below.
Once this candle close forms, place an order at the neckline of the head and shoulders. In my opinion, this gives you the best trading opportunity in terms of risk/reward.
A protective stop is placed just over the right shoulder, as if price trades considerably above here you should consider the trade idea void and move on to the next one!
Once your entry and protective stop are put in place, all that is left to do is manage the trade as price moves towards the next area where the opposite party will take control of direction.
You have to be very careful when looking for Head and Shoulders patterns in markets. A higher high followed by a lower high is a pattern that could literally form everywhere on a chart.
It is therefore vital when looking to execute this pattern, that before doing so you ensure the pattern set-up has all the components of a valid Head and Shoulders pattern!