This classic business model reported that the price of Bitcoin had peaked

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Traders tend to focus too much on the timing of the correct entry into a trade, but very few focus on developing a strategy to exit positions. If one sells too early, large gains are left on the table and if the position is held too long, the markets quickly recoup the profits. Therefore, it is necessary to identify and close a trade as soon as the trend starts to reverse.

A classic setup considered reliable for detecting a trend reversal is the Head and Shoulders (H&S) model. Over longer periods of time, the H&S pattern does not form often, but when it does, traders should take note and act on it.

Let’s take a look at some ways to identify the H&S model and when to act on it.

Head and Shoulder Bases

The H&S pattern is forming after a bullish phase and indicates that a reversal could be imminent. As the name suggests, the formation consists of a head, left shoulder, right shoulder, and a distinct neckline. When the pattern ends, the trend usually reverses direction.

Top with head and shoulders pattern. Source: TradingView

The image above shows the structure of an H&S model. Prior to the formation of the pattern, the asset is in an uptrend. At the top where the left shoulder forms, traders record profits, leading to a downside. This is the first low but it is not yet a strong enough signal to cause a trend change.

Lower levels attract buying again as the trend is still bullish and buyers manage to push the price above the left shoulder, but they are unable to maintain the uptrend.

Profit taking by buyers and short selling by countertrend traders pull the price lower, which finds support near the previous low. The junction of these two hollows forms the neck of the installation.

As the price bounces above the neckline, the bulls make another attempt to resume the uptrend, but as the price hits the height near the left shoulder, the profit reserve sets in and the rally collapses.

This lower peak forms the right shoulder and is usually aligned with the left shoulder. The upward movement is reversed and the sale accelerates. Finally, the bears manage to pull the price below the neck line. This completes the bearish pattern and the trend reverses from bullish to bearish.

Spot trend reversals with the H&S patternBTC / USDT daily chart. Source: TradingView

Bitcoin (BTC) started to rise sharply after hitting $ 20,000 in December 2020. The BTC / USDT pair hit a local peak at $ 61,844 on March 13 and the price corrected, forming a low on March 25. This local peak was the left shoulder.

The bulls saw the decline as a buying opportunity as the trend was still up. Aggressive buying then pushed the price above $ 61,844 and the pair hit a new all-time high of $ 64,854 on April 14. This level attracted sales, which pushed the price down to form the second low on April 25. other peaks formed the head.

Another attempt by the bulls to resume the uptrend failed on May 10. This formed the right shoulder and the ensuing correction snapped below the model’s neck line. The breakout and close below the neckline on May 15th completed this bearish pattern.

Sometimes after the outage the price will re-test the outage level from the neck line, but when the momentum is strong the retest may not happen, an example shown in the chart above.

BTC / USDT daily chart. Source: TradingView

To calculate the target pattern for this setup, determine the distance from the neckline to the top of the head. In this case, the value is $ 15,150. This distance is then subtracted from the break point on the neck line to arrive at the minimum target goal.

In the example above, the breakdown occurred at almost $ 48,000. This projected a model target at $ 32,850. This figure should be used as a guide because sometimes the drop exceeds the target, and in other scenarios the drop ends without reaching the target.

Head and shoulders sometimes fail

Sometimes traders take the plunge and take counter-trend positions before the price drops below the developing H&S formation neckline. Other times the breakout below the neck line does not result in subsequent sales and the price goes back above the neck line. These cases can cause the setup to fail, trapping aggressive bears who are forced to cover their positions, resulting in a short squeeze.

ADA / USDT daily chart. Source: TradingView

Cardano (ADA) initiated an uptrend from the $ 0.10 level on November 20, 2020. The uptrend hit resistance in the $ 0.35 to $ 0.40 area in January and an H&S pattern has started to develop. The price fell to the neck line on January 27, but the bears were unable to sink and close the ADA / USDT pair below support.

When the price rebounded from the neck line on January 28, it was a signal that sentiment remained bullish. There was a slight setback on Jan. 30 and 31 as the bears attempted to slow the bullish move near the right shoulder, but sustained bull buying pushed the price above the head on Feb. 1. This break above the model’s head invalidated the placement.

ADA / USDT daily chart. Source: TradingView

When a bearish setup fails, it takes several aggressive sellers off the wrong foot. This translates into a short squeeze and propels the price higher. The same thing happened in the example above and the pair soared in February.

Key points to remember

The H&S model is considered a reliable reversal model, but there are a few important points to keep in mind.

A slanted down or flat neckline is considered a more reliable model compared to a high neckline. Traders should wait for the price to drop and close below the neckline before initiating trades. Anticipating the setup could lead to losses as a failed bearish pattern could lead to a strong rally.

Pattern targets should only be used as a guide as sometimes the price may overshoot and continue to fall and at other times it may reverse direction before reaching the target goal.

The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move comes with risk, you should do your own research before making a decision.

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