The head and shoulders is one of a group of patterns typically considered trend reversal chart patterns. If you look closely though, the head and shoulders can also act as a continuation. There are some subtle differences between the continuation and reversal, which may just help you find some great trades, and avoid some bad ones in regards to this pattern.
Head and Shoulders Continuation Pattern
The continuation version looks very similar to the normal reversal head and shoulders, accept there are a few distinct differences:
- Continuation patterns occur after a sharp up (or run down). When looked at from a broad perspective, this makes the head and shoulders look more like a consolidation than a reversal pattern.
- The head and shoulders should also be about half the size (or less) of the sharp price run that preceded it. This isn’t an exact measurement, but it should look like a consolidation after a run up, therefore, it can’t cover as much distance as the price run before the pattern.
- If a potential continuation pattern occurs in an uptrend, the lows of the continuation should reach pretty close to the same level. If the last low is higher than the others, that is fine. If the price breaks significantly below the low point of the pattern, then it is likely a reversal instead.
- If a potential continuation pattern occurs in a downtrend, the highs of the continuation pattern should reach pretty close to the same level. If the last high is lower the others, that is fine. If the price breaks significantly above the highs of the pattern, then it is not a continuation pattern and more likely a reversal.
- If it is a continuation pattern, the expectation is for the trend to resume following the pattern.
Head and Shoulder Continuation Examples
Figure 1 shows a strong rally in the GBPUSD, followed by a not-so-pretty head and shoulders pattern.
Figure 1. GBP/USD Head and Shoulders Continuation Pattern – Daily Chart
This is what’s called a complex head and shoulders, since there are two left shoulders (not just one), the lows don’t perfectly line up and then there is a barely a pullback following the right shoulder.
In this particular case, the false breakout below the prior lows indicated the GBPUSD as likely to move higher. Then the higher low following the right shoulder signaled the price was likely to pop, which it did.
If you look closely you will see another smaller head and shoulders right after the one marked on the chart. That one lead to an ever sharper continuation of the trend.
Here is another one. Again it is an ugly pattern, but the attempts to move higher are clearly visible, and the lows stay above the original low. I have drawn a circle around the entire pattern, and notice how that circle is just a blip–consolidation– in the overall trend. Complex consolidations scare a lot of traders out of trades, or even cause them to reverse and go against the trend.
Figure 2. GBPUSD Head and Shoulders Continuation Pattern – 1 Minute Chart
Get used to seeing patterns like in Figure 1 and Figure 2. Let the pattern develop. Only if it drops out the bottom (uptrend) is the price likely to reversal.
You can buy near the support of the continuation pattern. This way, you can place a stop just below the pattern, keeping risk quite small, and your target can be well beyond the top of the pattern. For managing trade expectations, see Make a Little Money Before a Lot of Money.
These types of patterns occur in uptrends and downtrends. Don’t worry too much about how the pattern looks. If there is a strong price run prior the pattern, view the pattern as a consolidation, with the expectation that the trend (the prior strong run) direction will continue. If already in a trade, you can hold through the pattern, or you can enter during the pattern near support (uptrend) or resistance (downtrend) of the pattern. Assume it is a continuation until the point where it becomes a reversal. For more on consolidations see: Should I Hold Through a Pullback, or Get Out?, Part 1 and Part 2.