Head and Shoulders Pattern
With a Head and Shoulders pattern in the media on several occasions lately, I thought I would add a page of my own on the subject.
Everyone seems to have there own opinion on the outcome of this particular pattern and I guess I have my own as well.
Being a self taught trader, I take in as much knowledge as I can over periods of time, I interpret this knowledge which many times is varied from source to source, and then I come up with my own conclusions.
As time goes by, if I see my conclusions are incorrect, I adjust them to try and become more accurate with the goal of obtaining a higher probability of successful results.
Enough of how I come to my conclusions, let's move on to some of the characteristics of this particular chart pattern:
- A Head and Shoulders Pattern is generally considered a "Reversal Pattern", meaning whatever the trend was prior to the pattern itself, the trend after the pattern will reverse.
- The pattern can form at the top as well as at a bottom, in which case it is called a Head and Shoulders Bottom, or Inverted Head and Shoulders.
- A neckline can be drawn from both points of the neck at the base of the head and does not have to be perfectly horizontal.
- Volume plays a considerable role in recognizing this pattern.
- This pattern, like any other pattern, does not work 100% of the time. That is why there are "Fakeouts" and "Reversal" from within the pattern itself on occasion.
The first example below is showing a Head and Shoulders Top:
Notice the neckline I have drawn in Red and how I extended it for possible future support/resistance levels. You can also see that the trend prior to the pattern itself was up, then the pattern formed, and then a reversal which is now the downtrend shown.
Volume on the rise into the head should be lighter than the left shoulder indicating buying is weakening, and the volume on the rise into the right shoulder is usually even lighter than the head, leading to a final move lower from an increased number of sellers.
The next example is showing an Inverted Head and Shoulders bottom:
Notice that this is still a reversal pattern. The trend prior to the pattern was down, then the pattern formed, and then a reversal in the trend begins into an uptrend.
You can see the neckline again is drawn in red. Volume down into the head many times is lighter than down into the left shoulder, and volume up out of the head is heavier than the rise out of the left shoulder, showing that an increasing number of buyers are stepping in. Volume down into the right shoulder is lighter than the left shoulder as well.
Remember that a Head and Shoulders pattern is primarily a Reversal pattern. This means that whatever the trend was prior to the pattern will most likely reverse after the pattern is complete. If it does not, it is probable that the pattern was not a Head and Shoulders pattern to begin with, only similar.
Also keep in mind that the more people expecting a pattern to complete and take its expected path, the less likely it will happen. This occurred recently with the S&P and DOW in July 2009. The media was all over announcing the pattern as it was forming. What happened? Prices reversed and inexperienced traders who thought patterns always work were faked out and lost money.
Here are more pages to help with various chart patterns:
- Stock Chart Patterns
- Double Top- Swing Trading
- Intraday Double Top
- Intraday Double Top with MACD Indicator
- Ascending Triangle
- Intraday Ascending Triangle 06/11/2009
- Descending Triangle
- Symmetrical Triangle
- Elliott Wave