There are three major reversal patterns in Forex trading that have been identified as creating a significant trend reversal when they occur. The fist of these is called the “Head and Shoulders” because when it is charted it bears some resemblance to the head and shoulders of the human body.
The first shoulder is created as currency prices uptrend and hit a peak. Once the peak has been reached, there is a temporary halt in volume, followed by a downtrend to the support level, which completes the shoulder formation. At that point, trading again pauses until prices begin to rally in an upward climb that continues until hitting a higher price than the previous high price. Trading once again comes to a temporary moratorium and prices again begin the downward spiral to the support level, which completes the head formation. Trading pauses, followed by an uptrend to about the same level as the first high price. Then trading pauses again and prices take the final descent to the support level to create the second shoulder. A line can be drawn connecting the low points between the first shoulder and the head and the second shoulder and the head. This line is referred to as the neckline.
What information does this pattern reveal to the trader? The first piece of data is that this pattern usually signals that there will be a price decline. The low points in the formations indicate price support levels.
For traders who want to sell short, the pattern indicates when to buy and when to sell. After the price movement breaks through the neckline as the second shoulder is completed, the Head and Shoulders reversal pattern is complete and the uptrend that preceded this reversal pattern has been broken.
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