The Head and Shoulders chart pattern is often referred to as one of the most reliable reversal patterns in chart analysis. The pattern can help traders determine when to enter and exit a specific stock. The Head and Shoulders pattern gets its name from the three peaks of the price on the chart. Two of the peaks that form the shoulders are at roughly the same price where the head is much taller and forms a new high for the stock price in that period.
In most cases the Head and Shoulders pattern is found at the top of a bullish trend. Sometimes these trends can be slow and steady over the entire year or more commonly found after a sudden surge in momentum. Here is an example of what the Head and Shoulders pattern looks like.
There are some things to consider when spotting the Head and Shoulders pattern on a chart:
It’s important to find out why the bullish period is ending. Was there news? Or some sort of catalyst that caused the price to decline shortly? Is it over-sold or over-bought? These are important questions to ask. We recommend reviewing your favorite stock news source and looking at some momentum based oscillators such as the Money Flow Index.
The safest place to purchase the stock on this specific Head and Shoulders pattern is right after the price has declined after forming the head and just before the bullish run up of the second shoulder. Of course, this can be hard to confirm and hindsight is twenty-twenty. However, using other technical indicators a trader can help limit their losses.
Review the support and resistant levels when studying Head and Shoulders patterns. This can help determine your entry/exit points a little bit easier. Also study the volume and determine if the stock has enough volume to support the second shoulder.
When you see a Head and Shoulders formation appear on the chart it tells us that:
-There is a struggle amongst the buyers and the sellers.
-The buyers fail to push the stock any further and so sellers start taking profits.
-This brings the price back down to an attractive level and more buyers start to pile on.
-This momentum carries the price to the second peak.
-This peak, or head, is where a lot of the previous buyers feel comfortable exiting knowing that they don’t want to take a loss if the price reversal happens.
-In the process of this happening more sellers start to off-load and sometimes even stop losses are triggered.
-This brings the price back down to an attractive level a second time and interests even more buyers, possibly some that purchased on the ride up to the second peak.
-At this point the buyers are able to push the price of the stock up to the second shoulder and the pattern is formed.
-When traders see this pattern it indicates a bearish downtrend is about to happen so thus most short-term trading (i.e.: day trading) traders will exit and leave with a small profit.
-This will cause the price to decline and confirm the pattern.
Feel free to share some Head and Shoulders patterns below or even share your experiences trading them!