MerexMarkets has always taken the time to explain to you different trading facts, and trading related topics, because at MerexMarket we want MerexMarkets clients and MerexMarkets blog viewers to have the power of knowledge even when MerexMarkets is fully responsible for the accounts.

Today MerexMarkets will explain the reverse head and shoulders pattern which signals that an ongoing downtrend is in danger of reversal. It is most often found at the end of a strong and long-lasting downtrend, where most market participants are confident that the prices will keep falling, but are also aware that the trend is developing too fast, and don’t want to be the first to take risks. In this case, the head of the formation is driven by panic selling (although, due to the nature of the forex market, we might speak of overenthusiastic buying too.) The shoulders can be considered as a continuation of the ongoing trend, rather than saying anything about the ultimate outcome of the price action. As usual, the head and shoulders pattern may ultimately be proven to be nothing but a temporary period of consolidation, and the prices may continue on the previous direction with hardly a pause.

An Example by MerexMarkets would be on this hourly chart of the USDCHF pair, the head and shoulders pattern, depicted by the large circle in the middle, signals the end of a previous downtrend. Between 17th December, and 18th December, we see prices consolidating in an irregular formation which we choose to identify as the left shoulder of the HS pattern. But this is clear in hindsight only. At the moment, the traders would regard the price action as but a continuation of the downtrend prior to the development of the head and shoulders.

Later, as the price makes one very sharp dive, and a similarly sharp spike a few hours later, we note the development of the head of the HS pattern. This time, the indications are strong that the downtrend is in danger of being exhausted. As we see on the graph, prior to the spike which erased all the gains of the downtrend, all the downward legs were final, and marked new lows of the trend.

By MerexMarkets