Article 7: When the Pattern Fails: Trading the Failed Head and Shoulders
The Black Book of Day Trading Strategies
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Introduction
While the Head and Shoulders pattern is a reliable indicator of a trend reversal, it is not infallible. There are times when the pattern will fail, and the price will not follow through on the expected move. These "failed" Head and Shoulders patterns can be frustrating for traders who have taken a position based on the pattern's signal. However, a failed pattern can also present a unique trading opportunity for the astute and agile trader. This article will explore the phenomenon of the failed Head and Shoulders pattern, providing a framework for identifying these failures and a strategy for profiting from them.
The Anatomy of a Failed Head and Shoulders Pattern
A failed Head and Shoulders pattern occurs when the price breaks the neckline, but then reverses and moves back above the neckline (in the case of a top) or below the neckline (in the case of a bottom). This can happen for a number of reasons, including a sudden shift in market sentiment, a news event, or simply a lack of follow-through from the sellers (or buyers).
The key to identifying a failed pattern is to watch for a lack of momentum after the neckline break. If the price breaks the neckline on low volume and then fails to make a significant move in the expected direction, it is a sign that the pattern may be failing. A move back above the neckline on high volume is a strong confirmation that the pattern has failed.
The Psychology of a Failed Pattern
The psychology of a failed Head and Shoulders pattern is the inverse of the psychology of a successful pattern. In a failed Head and Shoulders Top, the bears who have shorted the market on the neckline break are trapped. As the price moves back above the neckline, they are forced to cover their positions, which adds to the buying pressure and can lead to a sharp rally. In a failed Head and Shoulders Bottom, the bulls who have bought the market on the neckline break are trapped. As the price moves back below the neckline, they are forced to sell their positions, which adds to the selling pressure and can lead to a sharp decline.
Trading the Failed Head and Shoulders Pattern
The strategy for trading a failed Head and Shoulders pattern is to take a position in the opposite direction of the expected move. In a failed Head and Shoulders Top, a trader would look to buy the market when the price moves back above the neckline. In a failed Head and Shoulders Bottom, a trader would look to sell the market when the price moves back below the neckline.
The entry point for a trade on a failed pattern is typically the point where the price moves back above (or below) the neckline. A stop-loss order should be placed below the low of the right shoulder (in a failed top) or above the high of the right shoulder (in a failed bottom). The profit target can be calculated based on the height of the pattern, but in the opposite direction of the original measured move.
A Practical Trading Example
Let's consider a hypothetical example of a failed Head and Shoulders Top in the stock of "Phoenix Corp." (ticker: PHNX). The following table shows the price and volume data:
| Date | Price (USD) | Volume (millions) | Event |
|---|---|---|---|
| 2026-11-02 | 80.50 | 7.2 | Left Shoulder Peak |
| 2026-11-09 | 76.25 | 4.8 | Trough 1 |
| 2026-11-23 | 85.75 | 6.5 | Head Peak |
| 2026-11-30 | 77.00 | 4.2 | Trough 2 |
| 2026-12-14 | 82.00 | 4.9 | Right Shoulder Peak |
| 2026-12-21 | 76.75 | 8.1 | Neckline Break |
| 2026-12-28 | 78.50 | 9.5 | Price moves back above neckline |
In this example, the price breaks the neckline at $76.75, but then reverses and moves back above the neckline to $78.50 on high volume. This is a clear sign that the pattern has failed. A trader could initiate a long position at $78.50, with a stop-loss order placed below the low of the right shoulder at $76.00. The original measured move target would have been $67.75 ($76.75 - ($85.75 - $76.75)). The new profit target would be in the opposite direction, and could be calculated as $78.50 + ($85.75 - $76.75) = $87.50.
Conclusion
Failed Head and Shoulders patterns can be a source of frustration for traders, but they can also be a source of opportunity. By understanding the anatomy and psychology of these failed patterns, and by having a clear strategy for trading them, traders can turn a potential loss into a profitable trade. The key is to be flexible, to be able to recognize when a pattern is not working, and to be willing to take a position in the opposite direction of the crowd. The failed Head and Shoulders pattern is a effective reminder that in the world of trading, the ability to adapt is paramount.