Here you will learn how to recognize and use the head and shoulders pattern for binary options trading. Technical analysis is based on the premise that past price movements and trends may help us predict what the future movements will be. We use charts in order to better visualize the data and identify these patterns. It’s a very complicated and interesting process, with its inherent intricacy based on the fact that we work primarily with probabilities and percentages.
However, this doesn’t mean that the predictions made using this method are inaccurate. A well-trained analyst can quickly spot trends and foresee price movements most of the time. In fact, the only reason a prediction might be inaccurate would be because of some unforeseen consequences or occurrences influencing the market in unanticipated ways.
Chart patterns are one of the bases of the process. Without the identification of chart patterns, charts would be nothing more than pretty pictures with numbers on them with no real information value. Throw patterns into the mix, though, and they become one of the most useful tools in the whole of technical analysis. Through their repetition, chart patterns help chartists make educated guesses about the state of the market in a certain moment in the future. It’s fascinating that we are able to do this even through all the unexpected movements on the market.
Past Events and Price Movements
As we’ve already talked about, one of the most basic principles of technical analysis is the repetition of past events and price movements. This is not just a random and unsupported statement – it’s actually based on the data provided by numerous chartists. Almost every chart has certain patterns that reoccur as you examine the chart further. By basing your assumptions on those patterns, you can essentially predict where the stock prices will be in a future moment and thus make a decision based on the supposed direction the price will go. A good chartist can find excellent trading opportunities even in the most nebulous of charts. This quintessential principle of technical analysis is what allows us to make good investments and minimize the risks concerning our stock purchases (note that this not mean that your profits are guaranteed).
It’s essential to make a distinction between the two sorts of basic patterns in technical analysis. One is called a continuation pattern and the other one – reversal pattern. The continuation pattern simply means that there is strong evidence to suggest that the trend will continue in the same general direction upon the completion of the pattern. Reversal patterns, on the other hand, suggest that the trend is about to reverse upon the completion of the pattern. But those are just the basics. Let’s venture forth into the intriguing field of chart patterns and explore them in more detail.
Head and Shoulders
Head and shoulders is among the most popular and reliable patterns in the whole of technical analysis. It’s one of the most easily recognizable reversal patterns. As you may recall from the previous paragraph, the fact that a pattern is categorized as reversal means that it indicates a high likelihood of an asset’s price going against the preceding trend.
There are two types of head and shoulders trend – normal and inverse. The normal one by far the more popular and easily recognized. It constitutes a head that is higher than the two shoulders, and a neck-line that presents the level of support. The normal head and shoulders trend signal the high probability of a trend reversal for an uptrend (which means that there was a prior uptrend that is now likely to end). You can see what this trend looks in the chart below.
The inverse head and shoulders looks a bit more interesting and a lot more nebulous. Unlike the normal version (where the “head” and the “shoulders” are clearly visible), inverse head and shoulders requires more expertise and experience to spot because it’s not that clear unless you know what you’re looking at. It’s the polar opposite of the normal version – it has a head that is lower than the shoulders, and the neckline represents the level of resistance. Unlike the normal head and shoulders, the invert variety signals of the potential reversal of a downtrend (which means we were observing a downtrend prior to the pattern, but it’s probably going to turn into an uptrend by the end). You can see what this trend looks like in the example below.
Both versions clearly show a deterioration in the pattern. The price movements are no longer consecutive which in most cases is a definite sign for a trend reversal.