Head And Shoulders Pattern

*Bob Iaccino, Chief Market Strategist and Co-Founder of Path Trading Partners, joins us live every Thursday from 11am ET, as our risk management educator. With 30 years' experience working as an active investor in equities, commodities, futures and FX there are few better to talk on the subject of risk management.

Bob has developed a method for breaking down his key fundamentals of risk management, in a way that he thinks retail traders can understand and use to get actionable insights to bring into their own trading. Below are some excerpts of Bob’s thoughts from a recent live session.

The head and shoulders pattern is a classic reversal formation in technical analysis, typically signaling a change in trend direction. It consists of three key price peaks: a left shoulder, a higher head, and a right shoulder that is usually similar in height to the first.

This formation marks a loss of momentum in the prevailing trend. After the higher high (the head), the market fails to reach new highs, forming the right shoulder—an early sign that the bulls may be losing control.

There’s also a variation known as the inverse head and shoulders pattern—or head and shoulders bottom—which follows the same structure in reverse. This version occurs after a downtrend and often indicates a bullish reversal.

Just like double tops and double bottoms, these are reversal patterns, not continuation ones. They may resemble those formations but with a distinct third rotation that provides more structure and nuance to the trend shift.

While the concept may initially seem simple, identifying head and shoulders patterns requires strict criteria. My partner, Mike Arnold, and I spent years analyzing historical market data to isolate high-probability setups. We’re highly selective when it comes to interpreting these formations.

One of the most critical elements of this pattern is the neckline, which connects the lows following the left shoulder and the head. A valid signal typically comes when the price breaks below the neckline (or above it in the inverse pattern).

To calculate a measured move target:

1. Measure the distance from the peak of the head to the neckline directly beneath it.
2. Subtract that distance from the price where the neckline breaks.
3. This difference gives you a projected downside target for a short entry.

In most cases, a trader would consider entering a short position once the neckline breaks, using the measured move as a price objective.

Key Components of the Pattern

Understanding each head and shoulders pattern segment is critical to spotting it early and validating its strength.

Left Shoulder

The initial peak occurs after an uptrend, followed by a retracement. This is the left shoulder, typically a moderate high that gives way to a pullback before the market resumes upward.

Head

The head is the tallest point of the pattern, formed when the price makes a new high, surpassing the left shoulder. However, this high is unsustainable, and the market reverses again.

Right Shoulder

The price attempts to rally once more but fails to reach the height of the head. This right shoulder often mirrors the structure of the left, signaling waning bullish momentum.

Neckline and Its Role

The neckline is drawn by connecting the two troughs (valleys) between the shoulders and the head. It acts as a trigger line: when broken decisively, it validates the pattern and often indicates a significant shift in sentiment.

The traditional head and shoulders generally have a bearish reversal pattern. It shows that the uptrend is losing steam, and sellers may take control. A break below the neckline confirms this shift and often triggers a move lower.

The inverse head and shoulders, however, is a bullish reversal pattern. It indicates that a downtrend is likely ending, and buyers are returning. Once the neckline is broken to the upside, it can initiate a new bullish trend.

So, the directional implication depends entirely on the type of pattern:

• Head and Shoulders = Bearish
• Inverse Head and Shoulders = Bullish

To trade this pattern effectively, there are a few core rules traders should consider:

• Wait for confirmation: Don't enter until the neckline is broken. Premature entries carry more risk.
• Use a measured move target: Project your price objective by measuring from the head to the neckline and applying that distance from the breakout point.
• Control risk with stop-loss orders: Place your stop above the right shoulder (or below in inverse patterns) to protect against false breakouts.
• Look for volume confirmation: A spike in volume during the neckline break often strengthens the pattern’s validity.

Following these guidelines can help traders avoid common mistakes and trade the pattern with more discipline and consistency.

A target is a point where action is required, not optional. You must take action at your target, especially if it’s a measured move target. You identified that target well before you entered the trade. The only time you can think clearly about a trade is before you're in it.

A common mistake many traders make is when they see the price approaching the target, they think, "Oh, I'm almost at my target," and feel relieved. But then the day closes, and the next day the market opens lower—remember, this green area is the open, and the bottom of this candle is the open. Suddenly, you're thinking, "Oh my God, I'm going to make a fortune on this trade."

Blinded by that thought, you might prematurely exit your trade or fail to adjust your stop. You don't tighten your trailing stop, or you hesitate to reduce your stop loss because you don’t want to get stopped out. This behavior is careless and potentially costly.

Live Sessions (hereafter referred to as the “Content”) are produced by TradeZero. The Content may include the views and opinions of TradeZero and a third-party participant, Bob Iaccino. Bob Iaccino is compensated by TradeZero for participating in the Content. Mr. Iaccino’s trading experiences and accomplishments are unique, and your trading results may vary substantially from his. TradeZero is not responsible for and neither affirms nor endorses any of Mr. Iaccino’s views or opinions expressed in the Content. TradeZero makes no representations or warranties with respect to the accuracy of the Content or information available through any referenced or linked third party sites. The Content has been made available for informational and educational purposes only and should not be considered trading or investment advice or a recommendation as to any security.

Trading securities can involve high risk and potential loss of funds. Furthermore, trading on margin is for experienced investors and traders only as the amount you may lose can be greater than your initial investment. Likewise, short selling as a securities trading strategy is extremely risky and can lead to potentially unlimited losses. Options trading is not suitable for all investors as it can involve risk that may expose investors to significant losses. Please read the Characteristics and Risk of Standardized Options, also known as the options disclosure document (ODD) at https://www.theocc.com/Company-Information/Documents-and-Archives/Options-Disclosure-Document before deciding to engage in options trading.

TradeZero provides self-directed brokerage accounts to customers through its operating affiliates: TradeZero America, Inc. a United States broker dealer, registered with the Securities and Exchange Commission (SEC) and member of the Financial Industry Regulatory Authority (FINRA) and the Securities Investor Protection Corporation(SIPC); TradeZero, Inc., a Bahamian broker dealer, registered with the Securities Commission of the Bahamas; and TradeZero Canada Securities ULC, a Canadian broker dealer, member firm of the Canadian Investment Regulatory Organization (CIRO) and member of the Canadian Investor Protection Fund (CIPF).