EMA-STOCHASTIC Head & Shoulders Trading Strategy

The head and shoulders chart pattern is widely recognized and easily identified in technical analysis. It’s a specific chart formation that predicts a shift from a bullish to a bearish trend.

As a trader, you’re probably familiar with this head and shoulders pattern. However, unfortunately, many traders aren’t exactly sure how to correctly utilize signals from the head and shoulders pattern.

It’s a pity because head and shoulders signals have a very high probability of success if you know how to use them.

Therefore, in this video, I’ll demonstrate how to triple the accuracy of the head and shoulders chart pattern to ensure our trades are profitable in both the short and long term.

Regardless of the chart pattern that suits you—whether it’s the head and shoulders, pennant , Double-top and Double-bottom, flag, or anything else—it’s crucial to have a process for each trading setup.

Here are 5 simple and effective steps on how a savvy trader approaches trading with the head and shoulders pattern.

• Step 1 – Identify Market Trend

When first looking at a stock chart, you want to determine whether the stock is in an uptrend, downtrend, or consolidation.

Determining the trend early on can help you develop a game plan more quickly. You’ll roughly know what the stock is doing, making it easier to identify low-risk trading setups.

So, whatever you do, remember to determine the overall trend before doing anything else.

• Step 2 – Before making any trades, it’s important to let the head and shoulders pattern complete itself.

If the pattern appears to be forming or is in the process of forming, you should not assume that the pattern will fully develop and trade based on what you believe will happen. Remember, “Trade what you see, not what you think.“

It’s crucial for traders to wait for the pattern to complete. This is because a pattern may not develop at all, or a partially developed pattern may not be complete in the future. Partial or almost completed patterns should be noted, but trading should not be done until the pattern breaks through the neckline.

So, remember to pay attention to the developing trend and be patient. Try not to get caught up in excessive anticipation.

• Step 3 – Trade the Pattern

Trading can commence once the pattern is complete. Plan your trade in advance, write down entry targets, stop-loss, and profit, and note any variables that may alter your stop-loss or profit targets.

For the head and shoulders pattern, we wait for price action to move lower than the neckline after the peak of the right shoulder. For the inverse head and shoulders, we wait for price movement above the neckline after the right shoulder is formed.

Another entry point requires more patience, and there’s a possibility that the move might be missed entirely. This method involves waiting for a pullback to the neckline after the breakout occurs. It’s more conservative as it allows us to see if the pullback stops and the early breakout direction continues; however, the trade might be missed if the price keeps moving in the breakout direction.

• Step 4 – Place Your Stop-Loss

The stop-loss is placed just above the right shoulder after the neckline is breached. Alternatively, the top of the pattern can be used as a stop, but this likely carries a much higher risk and thus reduces the risk-to-reward ratio of the pattern.

In the inverse pattern, the stop is placed just below the right shoulder. Again, the stop can be placed at the top of the pattern, although this exposes the trader to higher risk.

• Step 5 – Set Your Profit Target

The most common and often recommended profit target is the distance between the head and the neckline.

And how does that translate into a risk/reward ratio…? Since our first profit target or minimum is the distance between the head and the neckline, if we decide to use a conservative option for stop protection, then we will have the same distance as the loss limit, thus creating a risk-reward ratio of 1:1.

This is why, to improve this ratio, most experienced traders often place their protective stop above the peak of the right shoulder, considering they use the head-to-neckline profit target.

However, one thing that should always hold true is a favorable risk-to-reward ratio. So always make sure to calculate before making a trade.

After understanding all aspects of the Head and Shoulders pattern, let’s now discuss how to improve trading accuracy with head and shoulders.

• Diagnosing Stochastic Oscillator.

The purpose of the Stochastic oscillator is to ensure that the head and shoulders signal forms when the market is in oversold or overbought conditions.

If the head and shoulders pattern signal forms simultaneously with the market price movement in oversold or overbought conditions, the probability of trend reversal becomes higher.

• Diagnosing Exponential Moving Average.

Moving Average is a trend indicator. If the price is above the moving average line, it means the market trend is bullish. Conversely, if the price is below the moving average line, it means the market trend is bearish.

In this strategy, we use the EMA indicator with a period setting of 14 because this period represents the average price movement formed by the “Head and Shoulders pattern”. The period of 14 also matches the setting of the Stochastic oscillator, which is (14, 3, 3).

So, now how do we trade the Head and Shoulders pattern using the Stochastic Oscillator and Moving Average filter.

• Rule number 1. Market movement forms the inverse Head and Shoulders pattern.
• Rule number 2. When the inverse Head and Shoulders pattern forms, the Stochastic Oscillator is in the oversold area.
• Rule number 3. We wait for price action to move higher than the neckline after the valley of the right shoulder.
• Rule number 4. Price is above the 14-period EMA line.
• Rule number 5. Open a BUY position with Stop Loss below the nearest swing low. The minimum profit target is the distance between the head and the neckline.

 

• Rule number 1. Market movement forms the Head and Shoulders pattern. All Head and Shoulders rules have been discussed above.
• Rule number 2. When the Head and Shoulders pattern forms, the Stochastic Oscillator is in the overbought area.
• Rule number 3. We wait for price action to move lower than the neckline after the peak of the right shoulder.
• Rule number 4. Price is below the 14-period EMA line.
• Rule number 5. Open a SELL position with Stop Loss above the nearest swing high. The minimum profit target is the distance between the head and the neckline.

• Download “TraderVersity-EMAstochSystem” (Zip/RAR File).
• Copy mq4 and ex4 files to your Metatrader Directory …/experts/indicators/
• Copy the “TraderVersity-EMAstochSystem.tpl” file (template) to your Metatrader Directory …/templates /
• Start or restart your Metatrader Client.
• Select Chart and Timeframe where you want to test your forex system.
• Right-click on your trading chart and hover on “Template”.
• Move right to select “TraderVersity-EMAstochSystem” trading  system and strategy
• You will see “TraderVersity-EMAstochSystem” is available on your Chart

Head and shoulders is one of the most effective price action strategies you can use in the market. This system provides a method for trading the market based on logical price movements. It’s very easy to identify entry targets, stops, and profits, making it an effective strategy for both beginners and professionals.

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