Tag Archives: head

How to Trade the Head and Shoulders Pattern 2

Posted on by
Reply

In yesterday’s lesson we looked at the head and shoulders pattern and the reverse head and shoulders pattern; two reversal patterns that you look for at the end of up trends and the end of down trends to signal their reversal. In today’s lesson we are going to look at a specific strategy with entry and exit points for how to trade those chart patterns. So let’s get started.

Let’s start by looking at the strategy for trading the head and shoulders pattern. There’s our head and shoulders pattern that we looked at in the last lesson and the basic strategy here is we’re going trade the break of the neckline. If you remember from our last lesson, once the neckline is broken the pattern is said to be in place. And if you’re looking at an uptrend there and you see that then there’s a good indication there on the break of that neckline and the formation of the head and shoulders pattern that that trend is going to reverse. So we’re going to look to enter short on the break of the neckline.

The target for the trade we are going to get by measuring the distance from the head of the pattern to the neckline, then we’re going to project that down from the break point of the neckline. So after entering the trade on the break, we are going to place our stop-loss just above that right hand shoulder there which is considered the closest resistance.

So, you can see there how we are trading the break of support and then we’re placing our stop-loss just above the nearest resistance level. So let’s look at it here. So we get 430 points by measuring the distance there. We project that downward. After entering on the break, 430 point target there.

We place our stop-loss just above the right hand shoulder. For further confirmation that this is a good trade or a good pattern to enter on, traders are going to look at two things. Firstly, they are going to look for a downward sloping neckline that you can see here.

We have in this pattern as this is further indication that the market is reversing. If that neckline was upward sloping than that would be a sign that this might not be a good pattern to trade this time but since its downward sloping, it looks like it’s a good one to trade.

The second thing they are going to look for is declining volume on each of the rises up. So volume on the head should be lower than volume on the first shoulder. And volume on the right hand shoulder should be lower than the volume going up into the head.

Lastly, traders are going to look for increasing volume on that break of the neckline to verify that that’s a valid break of the support line there. OK, the reverse head and shoulders is basically the mirror image of the opposite of the head and shoulders.

We also are going to get our projected target by measuring the distance from the head to the neckline. We enter on the break there of the resistance this time since we’re flipped upside down.

Project our 610 point target from the break of the resistance line or the neckline there. And then put our stop-loss just above the right hand shoulder there as that is considered the nearest support level.

You can see how that’s sort of a flip or a mirror image of the head and shoulders pattern. Similarly to the head and shoulders pattern, on the reverse head and shoulders pattern traders are going to look for decreasing volume going into the head and then decreasing volume again going into the right hand shoulder.

And this time instead of a downward sloping neckline we are going to look for an upward sloping neckline to indicate and give us further confirmation that the pattern is in place and this might be a good pattern to trade.

Also similarly to the head and shoulders pattern we are going to look for increasing volume on the break of the neckline as further confirmation that that is a true break there. So that’s our lesson for today.

You should have a good understanding of the head and shoulders pattern and the reverse head and shoulders pattern as well as the strategy for trading each of them.

In our next lesson we are going to finish up on reversal patterns by looking at the rising wedge and falling wedge patterns and then we are going to move on to continuation patterns after that.

YouTube Preview Image

The 4th lesson in a series on charting patterns which looks at how to trade the head and shoulders pattern and the reverse had and shoulders pattern for daytraders.

How to Trade the Relative Strength Index (RSI)

Posted on by
Reply

In today’s lesson we’re going to look at indicators which are known as oscillators, starting with the one of the most popular oscillators, the RSI. So let’s get started!

An oscillator is a technical indicator which fluctuates above and below a central line and normally has an upper and lower band which indicate overbought and oversold conditions in the market. An exception to this upper and lower band component would be the MACD, which we learned about yesterday, which is an oscillator as well but is not encompassed by an upper and lower band. One of the most popular what’s known as banded oscillators is what’s known as the RSI, which is what we’re going to start our discussion on oscillators with today. The RSI’s best described as an indicator which represents the momentum in a particular financial instrument as well as when it’s reaching extreme levels to the upside which is referred to as overbought conditions or extreme levels to the downside which is referred to as oversold conditions.

The indicator accomplishes this through a formula which compares the size of recent gains for a financial instrument to the size of it’s recent losses. The results are then plotted as a line which fluctuates between 0 and 100. And bands are then placed at 70, which is considered an extreme level to the upside and 30, which is considered an extreme level to the downside.

This is what an oscillator looks like. You can see the price chart there. And you can see the RSI plotted to the bottom. And you can see the central line there at level 50, and the upper band at 70 and the lower band at 30. That’s what an RSI looks like when it’s plotted on a chart. And you can see how it fluctuates above and below those lines. We’re going to look at what that means next.

There’s several different ways that traders use the RSI in their trading. The first is to identify overbought and oversold conditions in the market. As we just talked about when the RSI is below the 30 line, this is considered an oversold level and therefore traders are going to look to trade a reversal of the trend there because the boat is tipped too far to one side so to speak.

The RSI goes below 30, the market bottoms there then turns upward. And then the market continues upward, goes into overbought territory on the RSI, and then you can see it turns downward after that.

The second way that traders use the RSI in their trading is what’s known as RSI divergence, and this is similar to what we learned about with the MACD divergence. If the indicator (the RSI) is trading in the opposite direction or trending in the opposite direction as the price action of the financial instrument that you’re analyzing, this tells you that momentum is waning and therefore that particular financial instrument may be due for reversal.

So, you can see here the market is making a new high, but the RSI is not. And that is a divergence there showing that the market may be running out of steam. In that case it was, and it sold off pretty dramatically right after that.

The third way that traders use this in their trading is known as the centerline crossover. And this you know a less reliable signal than the first two so you definitely going to want to use this one in conjunction with some of the other things that we’ve learned about or some of the things that we’re going to learn about in future lessons.

But basically what this is, is when the RSI crosses above the 50 line that’s considered a bullish sign, and because the market is making more highs and more making more gains than it is losses. When it crosses below that center 50 line that’s considered a bearish sign because the market is making more losses than gains.

You could use that and how it would have actually worked very well recently trading the euro-dollar. You could see there’s a head and shoulders pattern there, that we learned about in one of our previous lessons. And then you can see the RSI makes a bearish crossover confirming, so to speak, that that break below the neckline of the head and shoulders pattern is legitimate. In that case you would caught a nice big candle down, and might catch a few more in the days that come as a result of that confirmation.

So that’s our lesson for today. You should now have a good understanding of the RSI and how traders use this in their trading. And then tomorrow’s lesson we’re going to look at another oscillator which is known as the stochastic oscillators.

YouTube Preview Image

A lesson on how to trade the RSI. In our last lesson we looked at 3 different ways that the MACD indicator can be traded. In today’s lesson we are going to look at a class of indicators which are known as Oscillators with a look at how to trade one of the more popular Oscillators the Relative Strength Index (RSI).

An oscillator is a leading technical indicator which fluctuates above and below a center line and normally has upper and lower bands which indicate overbought and oversold conditions in the market (an exception to this would be the MACD which is an Oscillator as well).

One of the most popular Oscillators outside of the MACD which we have already gone over is the Relative Strength Index (RSI) which is where we will start our discussion. The RSI is best described as an indicator which represents the momentum in a particular financial instrument as well as when it is reaching extreme levels to the upside (referred to as overbought) or downside (referred to as oversold) and is therefore due for a reversal. The indicator accomplishes this through a formula which compares the size of recent gains for a particular financial instrument to the size of recent losses, the results of which are plotted as a line which fluctuates between 0 and 100.

How to Trade the Head and Shoulders Pattern

Posted on by
Reply

In previous lessons we looked at the double top pattern and the double bottom pattern which are two charting patterns which show that the momentum needed to break a resistance level, if we’re talking about a double top, or a support level, if we’re talking about a double bottom, is not there in the market. Because of this, when these patterns show up on a chart, traders look to trade a reversal of the current trend.

In today’s lesson we’re going to look at two more patterns which also show that the momentum needed to break a resistance level or a support level is not there in the market, which are known as the head and shoulders pattern and the reverse head and shoulders pattern. After we have a good understanding of these two indicators, then we’re going to look at a specific strategy with exact entry and exit points of how you can trade them. So let’s get started.

A head and shoulders pattern is basically defined as one peak in the market followed by a second higher peak in the market followed by a third peak which is lower than the second peak. So let’s take a look at what we’re seeing here on a chart. So you can see here, what forms the first peak is buyers in control drive the market up to a certain level, and then sellers take back control driving the market down which forms the first trough. Buyers then take back control which runs up to the second higher peak which forms the head of the pattern.

Sellers back in control to form the second trough before buyers take back control and form the second shoulder of the pattern which is the third peak. And then the pattern is completed when the neckline is broken which is formed by the two troughs.

The support level for this pattern is the two troughs which are formed between the shoulders and the head of the pattern. So you can see that there. So once that level’s broken that completes the pattern, and the market is theoretically supposed to sell off from there. And you can see why because the markets tried to push up three times, to go higher, and failed. So you can see where sellers will take control there.

The reverse head and shoulders is basically a mirror image of the head and shoulders pattern. And, basically, this is defined as one trough in the market followed by a second lower trough followed by a third higher trough. And you can see here the first shoulder being formed by sellers in control driving down into the first shoulder, and then buyers taking back control which forms the first peak of the pattern.

Before sellers take back control forming the head of the pattern. Buyers back in control forming the second peak of the pattern. And then sellers back in control to form the second shoulder of the pattern. And you can see there the neckline being drawn off of the top of the two peaks in between the two shoulders and the head this time.

And traders look for a break of that neckline which confirms the pattern is in place and has completed. OK. So you can see there instead of the resistance levels on the head and shoulders pattern, what is happening here is the market is failing to break support. And so, after it’s failed three times at three different levels, buyers theoretically will be in control for a good portion of the time after that.

So you should now have a good understanding of two more reversal patterns. In the next lesson, we’re going to look at a specific strategy with entry and exit points that traders use to trade these patterns.

YouTube Preview Image

The 3rd lesson in a series on charting patterns which looks at the head and shoulders pattern and how traders use them.