Carry Shoulder

Carry Shoulder

Head and Shoulders Pattern Can Signal a Trend Change

The head and shoulders pattern is one of the most reliable of indicators, when it comes to signalling a reversal of trend. The pattern looks just like it's name. You have the top which forms the head, sandwiched between two minor peaks, which are the shoulders. The right or second shoulder should be a little below the left shoulder.
 
The best way to spot a head and shoulders pattern is by utilizing a weekly chart. I will also use a daily chart. This pattern, like most, reflects important human emotions such as greed, fear, and hope. Never underestimate the importance of psychology in the markets. The pattern can take several months or more to complete.
 
The head and shoulders pattern that can signal the end of an uptrend is called a head and shoulders top pattern. The pattern can also signal the end of a downtrend. This is called a head and shoulders bottom pattern. I have found both the top and bottom patterns especially effective, when a market is at historical levels.
 
The three phases of the head and shoulders top pattern:
 
1. There is a rally which forms the left shoulder. This is followed by a downward price reaction. Volume is usually heavy during the formation of the left shoulder.
 
2. A second rally, which forms the head, carries the stock higher than the first rally. This is followed by a downward price reaction that erases most of the gain, leaving the price close to the previous low. Volume is heavy on the rally part, but usually a little less than the left shoulder.
 
3. The third rally, which forms the right shoulder, does not reach the peak of the head before another downward price reaction takes place. You want the formation of the right shoulder to show weakness. If volume is quite a bit less on this rally, you can take it as solid evidence there will most likely be a reversal coming up. Volume is a major factor determining whether a chart pattern is valid or not.
 
The head and shoulders bottom pattern looks exactly the same on the chart as a head and shoulders top. The only difference is that it's upside down, and marks the end of a downtrend, instead of the end of an uptrend.
 
It is never wise to regard the head and shoulders pattern as complete until the price breaks below the neckline. You get the neckline by drawing a line tangent with the lows of the left and right shoulders. Many times a rally will carry the price back to the neckline, which is called the return move.
 
There are several variations of the head and shoulders pattern. You can get a head which is not a point or curve, but ends out a flat top. It can be a sideways congestion range. Sometimes you can get a smaller pattern contained within a larger one. You can also get more complex formations that have two left shoulders, two heads, and two right shoulders. 
 
 

About the Author

Hi, I'm Gary E Kerkow, founder of Tradingmarkets4u.com. This site provides information to help traders and investors become successful. I have over 20 years of trading experience including stocks, futures and options. I implement the strategies, methods, and psychology of the world's best traders and investors. This includes Jesse Livermore, William J O'Neil and others. Visit my website at http://www.tradingmarkets4u.com

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