The head and shoulders pattern is a popular chart pattern among forex traders. It is a reversal pattern that signals the end of an uptrend and the beginning of a downtrend. While this pattern can be highly profitable if traded correctly, many traders make common mistakes that can lead to losses. In this article, we will discuss these mistakes and provide tips on how to avoid them.
Mistake #1: Failing to Confirm the Pattern
One common mistake traders make is failing to confirm the head and shoulders pattern before entering a trade. The pattern consists of three peaks, with the middle peak (the head) being higher than the other two peaks (the shoulders). To confirm the pattern, traders should wait for the price to break below the neckline, which connects the lows of the two shoulders. This break confirms the reversal and signals the start of a downtrend. Failing to wait for confirmation can result in false signals and losses.
Mistake #2: Ignoring the Volume
Volume is an important factor to consider when trading the head and shoulders pattern. Typically, the volume should decrease as the pattern forms and increase when the price breaks below the neckline. This indicates that sellers are gaining control and confirms the validity of the pattern. Ignoring the volume can lead to missed opportunities or entering trades with weak confirmation.
Mistake #3: Placing Stops Too Close
Another mistake traders often make is placing their stop-loss orders too close to the entry point. While it is important to limit potential losses, placing stops too close can result in premature stop-outs. The head and shoulders pattern can be prone to pullbacks before the downtrend resumes. Therefore, it is crucial to give the market enough room to breathe. Traders should consider placing their stops above the right shoulder or above the highest point of the pattern to avoid being stopped out too early.
Mistake #4: Neglecting Risk Management
Risk management is a vital aspect of trading any pattern, including the head and shoulders. Traders should determine their risk tolerance and adjust their position sizing accordingly. It is recommended to risk only a small percentage of the trading account on each trade, typically 1-2%. Neglecting risk management can result in significant losses and wipe out the trading account.
Mistake #5: Overtrading the Pattern
Overtrading is a common mistake that many traders fall into. They become overly excited about the potential profits from the head and shoulders pattern and start looking for it on every chart. However, not all patterns are created equal, and trading every possible head and shoulders pattern can lead to losses. It is important to be selective and only trade patterns that have strong confirmation and meet the trader’s criteria.
Mistake #6: Failing to Adapt to Market Conditions
Market conditions can change, and the head and shoulders pattern may not always be effective. Traders should be aware of the overall market trend and consider other factors such as support and resistance levels, fundamental analysis, and market sentiment. Failing to adapt to market conditions can result in trading against the trend or entering trades in unfavorable market conditions.
In conclusion, trading the head and shoulders pattern can be profitable if traders avoid common mistakes. It is crucial to confirm the pattern, consider volume, place stops at appropriate levels, practice proper risk management, avoid overtrading, and adapt to market conditions. By following these tips, traders can increase their chances of success when trading the head and shoulders forex pattern.