Head and Shoulders Top

Head and Shoulders Top

A Head and Shoulders reversalpattern forms after an uptrend, and its completion marks a trend reversal. Thepattern contains three successive peaks, with the middle peak (head) being thehighest and the two outside peaks (shoulders) being low and roughly equal. Thereaction lows of each peak can be connected to form support, or a neckline.

As its name implies, the Head andShoulders reversal pattern is made up of a left shoulder, a head, a rightshoulder, and a neckline. Other parts playing a role in the pattern are volume,the breakout, price target and support turned resistance. We will look at eachpart individually, and then put them together with some examples.

Prior Trend: It is important toestablish the existence of a prior uptrend for this to be a reversal pattern.Without a prior uptrend to reverse, there cannot be a Head and Shouldersreversal pattern (or any reversal pattern for that matter).

Left Shoulder: While in anuptrend, the left shoulder forms a peak that marks the high point of thecurrent trend. After making this peak, a decline ensues to complete theformation of the shoulder (1). The low of the decline usually remains above thetrend line, keeping the uptrend intact.

Head: From the low of the left shoulder,an advance begins that exceeds the previous high and marks the top of the head.After peaking, the low of the subsequent decline marks the second point of theneckline (2). The low of the decline usually breaks the uptrend line, puttingthe uptrend in jeopardy.

Right Shoulder: The advance fromthe low of the head forms the right shoulder. This peak is lower than the head(a lower high) and usually in line with the high of the left shoulder. Whilesymmetry is preferred, sometimes the shoulders can be out of whack. The declinefrom the peak of the right shoulder should break the neckline.

Neckline: The neckline forms byconnecting low points 1 and 2. Low point 1 marks the end of the left shoulderand the beginning of the head. Low point 2 marks the end of the head and thebeginning of the right shoulder. Depending on the relationship between the twolow points, the neckline can slope up, slope down or be horizontal. The slopeof the neckline will affect the pattern's degree of bearishness—a downwardslope is more bearish than an upward slope. In some cases, multiple low pointscan be used to form the neckline.

Volume: be the measured as an indicator (OBV, Chaikin Money Flow) or simply by analyzing volume levels. Ideally, but not always, volume during the advance of The left shoulder should be higher than during the advance of the head. Together, the decrease in volume and the new high of the head serve as a warning sign. The next warning sign comes when volume increases on the decline from the peak of the head And then during the advance of the right shoulder. Final confirmation comes when volume further increases during the decline of the right shoulder.

Neckline Break: The head and shoulders pattern is not complete and the uptrend is not reversed until neckline support is broken. Ideally, this should also occur in a convincing manner, with an expansion in volume.

Support Turned Resistance: Once support is broken, it is common for this same support level to turn into resistance. Sometimes, but certainly not always, the price will return to the support break, and offer a second chance to sell.

Price Target: After breaking neckline support, the projected price decline is found by measuring the distance from the neckline to the top of the head. This distance is then subtracted from the neckline to reach a price target. Any price target should serve as a rough These factors include include support levels, Fibonacci retracements, or long-term moving averages.

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