Head and Shoulders Top
A head
and shoulders top is a reversal pattern which occurs following an extended
uptrend. This bearish pattern is named for the three highs which form a
left shoulder, head, and right shoulder. The sell or
short sell signal is when price breaks
below the neckline which forms along the reaction lows.
Context: The head and shoulders pattern occurs after a lengthy uptrend
and is a topping pattern for a stock. Volume in the formation of the left
shoulder is often higher than volume in the formation of the head, confirming
that price is advancing with less participation. This is a reliable
indicator of a potential reversal to the downside.
Appearance: The head and shoulders pattern must follow an extended
price rise or uptrend. Price makes a high which forms the left shoulder
and reacts to a minor low. Price then achieves a major high (exceeding the
prior high) which forms the head, and then reacts to another minor low.
Price then rallies one final time to form a minor high which forms the right
shoulder of the pattern. The minor lows are connected with a
trend line
which will often slope upward, and this trend line is referred to as the
neckline. A downside break of the neckline is the sell signal or short
sell signal for this pattern, and confirms its identity.
Breakout Expectation: A head and shoulders top pattern is confirmed
with the downside penetration of the neckline. To determine a price
objective from the confirmation level, subtract the distance from the top of the
head to the neckline. Because these patterns are known to mark important
and lasting tops, the downside move which follows may exceed the distance from
the had to the neckline and be met with additional selling.
This stock formed a head and shoulders top after a big
price advance. Once price penetrated the neckline to the downside, the
stock moved lower.
Be sure to learn about the inverted head
and shoulders, also called the
head and shoulders bottom.
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