Tracking Head And Shoulders Pattern In Sideways Market

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Simpler Trading Team

Apr 04th 2022  .  6 min read

Tracking Head And Shoulders Pattern In Sideways Market

2022-04-04

How do Simpler’s traders make sense of a market caught in wide chop that gives off sporadic bullish vibes? Stock charts are revealing potentially bearish moves and these have traders sitting up in their chairs.

This springing to attention is fueled by the head and shoulders pattern on stock charts.

(Check out the free video, above, for insight into trading this changing market.)

Are traders stuck with sideways movement?

An important concern circling around the Simpler Trading online chat rooms focuses on “what to do” when trading in a market that seems to be stuck in a range – moving sideways.

Simpler’s traders are hopeful for a breakout above the previous high into bullish territory or for movement to lower lows to the previous level of support. These moves can occur in the broader market or in any of the major indices – the S&P 500, the NASDAQ, the Dow Jones Industrial Average, or the Russell 2000. It can also occur in bonds, commodities, or foreign exchange.

When stock or asset prices remain consolidated within a tight range for a period of time, this is referred to as sideways movement. A sideways market trades within preceding levels of resistance and support – also known as a “range-bound market.”

By contrast, trading in a bear market, where the market has experienced a 20% drop, or in a bullishly upward trending market is easier for traders to maneuver with proven strategies.

While a sideways market is not a crowd favorite, the team at Simpler Trading has years of experience working on strategies and methods to find potential trades in a sideways market.

Will new quarter provide fresh start?

As we start a new quarter, traders at Simpler tend to look for the opposite price action than that of the prior week.

The mild selloff through the week and into Friday has traders watching to see if the technology index can make it back to previous highs. If so, this could present an opportunity to short the head and shoulders pattern that appears to be looking to wrap up.

The head and shoulders pattern is a bearish reversal pattern that, minus the noise of market chop, gives traders a clear pattern of three components that resemble a head and shoulders (like an emoji on the chart). This pattern forms in an uptrend and is not complete if the second shoulder is not fully formed.

Could the patterns reveal short-lived strength in the new quarter before a potential rollover? Or is this really a fresh start in the market?

Traders at Simpler are looking for strength in the broader market to show itself before the week ends. They do this by stepping back to see the potential of the S&P 500 making it to $4,600 one more time. This would mean buyers are getting back into the market with a higher level of participation.

Selloffs hit technology index

The end-of-week selloffs that wrapped up the first quarter caused many traders to pause and assess the technology-heavy Nasdaq and an S&P 500 unable to move into neutral territory. Selloffs sent prices falling in the technology index.

Traders at Simpler are looking for strength to show up in the market – and maybe even a gap up as a bonus. Should the broader market move aggressively lower that could create a new narrative. Signals traders might see are negative ticks, a put-call ratio going sky high, or an advanced decline.

If a head and shoulders pattern sets up in the Nasdaq, Simpler’s traders have a plan in place to take advantage of this movement.

‘Gold old days’ of past markets fading away

Sideways trading could be an overarching strategy in this non-trending market. While it may not be as enjoyable, there is always a market to trade – whether favorable… or not so much.

Traders are aware that the “good old days” of 2020 and 2021 are fading, and this year looks to be a different trading environment. Should this market give up signals for “false buying” – it could go spike higher and drop again.

Trades should review trading strategies to determine where to place trade entries. This week could provide more insight to give traders at least a few answers to those questions.

Importance of market participation – more traders

Higher participation and strength means the market could continue its previous chop within range.

Should bullish opportunities present themselves in the indices, traders in bullish positions should watch for the fulfillment of the head and shoulders pattern forming in the technology index. Traders who need to get a bird’s eye view of the pattern can use the weekly chart to get a better look.

If a run higher occurs, Simpler’s traders are prepared for short trades to follow the price action of the head and shoulders pattern.

The market could present either massive strength or sideways failure leading to trading at lower than current levels.

Watching for head and shoulders patterns

Chart patterns are a foundation for traders working to anticipate market movement.

The head and shoulders pattern is composed of three components – chart peaks that resemble the left shoulder, head, and right shoulder of a person’s silhouette profile.

The pattern – which is preceded by a bullish trend – rises to a peak, declines to form a trough (or neckline), rises again as it moves higher than the previous high, declines once more, and finally rises one last time to the level of the first peak. 

When the price action declines once more, this is believed to be a reliable indicator of a trend reversal – or that a trend is nearing its end.

The initial peak and decline are signals that momentum is declining. It also means that there are fewer market participants who own that particular asset and that results in waning stock prices.

A bull rally to push the price back up is possible as long as the market participants get back into the market and continue the upward trend.

If technology stays bearish, what next?

If a rally in the Nasdaq does not happen soon, this could mean there is a market dominance transition from technology over the past two years into commodities.

Should that happen, Simpler’s traders may choose to look at long plays in commodities such as cocoa, wheat, soy, and cattle that have boosted the interest of traders. Copper and nickel also have potential.

In this market, traders might consider at least some amount of short exposure in the event the bearish momentum gains traction into lower lows in the indices.