Logo Background RSS

Advertisement

Head & Shoulders Topping Patterns

  • Written by Syndicated Publisher No Comments Comments
    July 12, 2010

    The head-and-shoulders top is one of the most well-known of all technical chart patterns. The pattern is easily recognizable and usually highly reliable. Thomas Bulkowski who wrote ‘The Encyclopedia of Chart Patterns’ conducted a study of these patterns and found them to break downward and continue to move down 93% of the time. He also found that the slope of the neckline and a lower right shoulder predict a more drastic price decline after the chart pattern confirms (although not statistically significant).

    Appearance

    Essentially the pattern is just as it’s name suggests – ‘a head and shoulders’ that consists of a left shoulder, a head and a right shoulder seen clearly in the chart below below;

    Typically, the left shoulder often appears after an up move and it will usually have the highest volume, followed by the head, with much lower volume at the right shoulder. A neckline is drawn along the bottoms of the three peaks and may slope in any direction. Often the slope of the neckline can predict the severity of the expected price decline.

    Basic Guidelines

    A head-and-shoulders top often appears at the end of an up trend whether it be short or long in duration. Sometimes the pattern may have multiple shoulders sand multiple heads but the general characteristics are clearly identifiable, despite the fact that that they sometimes may not be very symmetrical.

    In general, shoulders should be close to the same distance from the other and the head must of course be centrally located. The somewhat symmetrical appearance of a head and shoulders pattern is one of the essential components to identifying this pattern.

    Volume should generally be higher on the left shoulder than on the head and higher on the head than on the right shoulder.

    The neckline of the pattern acts as the break point of pattern confirmation point – when prices break the neckline and continue moving down in earnest. About half of the time a pull-back to or just above the neckline occurs and usually takes 2 weeks or less.

    The basic rule for the length of the decline following a neckline break is that it is a measure of the height from the head to the neckline and subtracts the result from the point where prices break the neckline. Generally this target is met about 65% of the time according to Bulkowski.

    Failed Patterns

    Failed head and shoulders patterns are not common. If this is the case, the pattern will often morph into a continuation or consolidation for further movement in the previous direction. According to Thomas Bulkowski, only about 7% of these patterns fail.

    Trading These Patterns

    Once prices break the neckline, subtract the distance of pattern from head height to the neckline from the daily high at the breakout point. This target then acts as a minimum price move objective. This is seen clearly in the chart below (lines in red highlight the measured price moves).

    From time to time, prices rebound at the neckline and move higher. Since prices usually pierce the neckline on their way down be aware that it may bounce up at the neckline and then continue down after moving horizontally or following the neckline. Sometimes general market conditions or other companies in the same industry can provide a directional guide. If they show weakness, expect your stock to follow the crowd and prices to move lower. If you plan to sell short, place your stop-loss order just above the neckline or the nearest resistance level.

    If prices pull back to the neckline, consider adding to your short position. However, be sure to wait for prices to begin falling after a pull back. Occasionally, prices will pull back and continue rising.

     
    Share on FacebookTweet about this on TwitterShare on Google+Share on LinkedInPin on PinterestShare on StumbleUponShare on RedditShare on TumblrDigg thisBuffer this pageFlattr the authorEmail this to someonePrint this page

Advertisement

Closed Comments are currently closed.