Trend Reversal Patterns

Double Top, Head & Shoulders, Rising Wedge

In our previous article we’ve described the downtrend reversal patterns and considered the best entry points, trading strategies and Stop Loss placement techniques.

Now we will analyze such trend reversal patterns referred to as Head & Shoulders, Double Top and Rising Wedge, signaling the uptrend reversal.

Head and Shoulders

The formation

The head and shoulders pattern depends on the timeframe and the strength of the upward movement. It is vital to pay attention to the distance between the tops when analyzing the pattern: equidistant distance between the head and shoulders indicates the higher probability of the figure’s formation. Also the more horizontal the neckline is, the higher the chances of the reversal are.

Entry point and Stop Loss placement

Entering a short position after the support line is broken: In this case you do not wait for the neckline retest to confirm the breakout. The risks lie in a chance of a false breakout and the formation of a bear trap. This could lead to the failure of the pattern’s formation and continuation of an uptrend. Stop Loss should be set at the right shoulder levels. A tight Stop Loss above the neckline would be optimal.

Entering a short position after the neckline’s retest: This strategy requires waiting for the price to return to the support line. Stop Loss in this case can be set at or above the right shoulder. When choosing this strategy, it is worth keeping in mind that price may continue its movement without retesting a neckline.

Key features

Tighter Stop Loss is advised and may be set above the support level to trade in a safer fashion and reduce risks. Keep in mind that in this case, the chance of Stop Loss execution caused by sudden increase in volatility is higher. Also take into consideration the specifics of the market and the asset you trade while determining when to close your position.

Double top

The formation

Opening a position

A breakout below the neckline is a signal to open a trade, but if you prefer a more steady and low-risk approach, it is suggested to wait for the retest of the support level. When opening a trade at breakout it is important to set a tight Stop Loss, just above the support line. This technique is preferable in terms of risk management.

Use additional tools and indicators to confirm the formation of the figure. Having additional information about the price behavior, you can enter a short position with a tight Stop Loss earlier (e.g., at the end of the formation of the second top), before breaking through the neckline.

Rising wedge

The formation

The price should gradually get squeezed in the channel, after which a sharp impulse and a break through the support level should follow. The breakout is characterized by the increase of the trading volume, which can be a signal confirming the figure’s formation.

Entry point and Stop Loss placement

If you utilize additional analysis tools and have trading experience, you can try opening a short position at the upper border of the rising wedge, setting a tight Stop Loss. Volume indicators are a great example of additional tools, useful when analysing such formations. A decrease in volumes during an uptrend, also known as divergence, signals the drop in buying pressure, which can cause a trend reversal.

Conclusion

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