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Now dont confuse the head and shoulder with the name of a shampoo. It is a chart pattern that you must be familiar with if you want to continue reading this article otherwise first make yourself clear about these chart patterns and then continue reading this article. For the most part these chart patterns are traded when a breakout of one or another kind occurs.
Now when we talk of pattern breakouts it should be clear which chart patterns constitute a continuation pattern and which chart patterns are considered reversal patterns. The second type of chart patterns that are the Japanese Candlestick patterns! Candlestick patterns are not tied as closely with breakout trading.
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The most common chart patterns found on the currency charts that are generally considered to be reversal formations include double tops/bottoms, triple tops/bottoms and head and shoulder tops and bottoms.
The most common chart patterns that are generally considered to be continuation patterns include flags, pennants, triangles, wedges, rectangles and others. When a continuation pattern approaches breakout on the side of the pattern that would denote a continuation, technical traders patiently wait for a breakout.
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Pattern trading is like playing with shapes and is very similar to the general support/resistance breakout trading in terms of entries and exits. One benefit of pattern trading lies in the precise profit targets. This type of trade is treated as a breakout trade with similar type of entry and stop loss placement as with standard support/resistance breakout trades.
The traditional signal for the trade in the head and shoulder pattern is after that price breaks the neckline. Profit target is derived by measuring the height from the top of the head to the neckline then projecting that height from the neckline breakdown for the profit target. So a good example of a precise profit target is that of the head and shoulder pattern.
Similarly in case of the rectangle consolidation pattern, the height of the rectangle is projected up or down to derive the profit target after the breakout. Triangles, flags, pennants and other chart patterns also have convenient build in profit targets.
Japanese candlesticks have recently become popular among the western trading circles. Steve Nison is considered to be the authority on Candlestick Charting. Candlestick patterns are most often used as important trade confirmation tools in conjunction with other technical indicators. Candlestick patterns in themselves are not usually considered as sufficient trading signals.
There are a number of candlestick patterns both simple and complex that can be used. For example, it should not be taken as a reversal signal to buy low if the hammer candlestick pattern occurs after a steep well defined down trend. However, if this hammer candlestick pattern occurs right at a well established support level, the hammer candle may be taken as a strong signal that a potential long trade may be profitable.
