Head and Shoulders Top

 

How do a classic head and shoulders top look?

As pictured below, the classic head and shoulders top looks like a human head with shoulders on both sides of the head. A classic design of the pattern has three sharp high spots, formed by three progressive rallies in the price of the stock.

Head and Shoulders Top pattern

 

The first spike is the left shoulder. It occurs as the price of the stock in a rising market hits a high and then falls back. 

The second spike is the head. It happens when prices rise to an even greater high and then fall back again.

The third spike is the right shoulder. It befalls when prices rise again but don’t catch the high of the head. 

Prices then fall back again after they have hit the high of the right shoulder. The shoulders are lower than the head. 

In a classic configuration, are approximately equal.

A key part of this pattern is the neckline. The neckline is determined by drawing a line connecting two low price points of the formation. 

How does it appear?

The first low point happens at the end of the left shoulder and the beginning of the uptrend to the head. 

The second shows the end of the head and the beginning of the upturn to the right shoulder. The neckline can be horizontal or it can slope up or down. 

If you ever see a Head and Shoulders Top neckline that is sloping downwards, you have to know that it is extremely unusual and confirms big vulnerability or weakness

The pattern is finished when the support provided by the neckline is “broken.” This happens when the price of the stock, falling from the high point of the right shoulder, moves below the neckline. 

The pattern is not confirmed until the price closes below the neckline. This means it is not enough for it to trade below the neckline.

In other words, this pattern is created by drawing trendlines, which connect a series of peaks and troughs. The trendlines create a barrier, and once the price breaks through these, it is usually followed by a very sharp movement in price.

Volume is extremely important for this pattern. 

Volume is highest when the left shoulder is forming. In fact, the volume is often increased as the uptrend proceeds and more and more buyers want to get in.

Volume is lowest on the right shoulder as investors see a reversal happening. The low volume levels on the right shoulder are a clear sign of a reversal.

In fact, the volume falls someplace between the strength of the left shoulder and the weakness of the right shoulder. 

Volume often increases when the neckline is broken as the reversal is now complete and downside pressure begins in earnest. One of the key characteristics in a Head and Shoulders Top is a very high volume on the breakout.

How can you trade this pattern?

 

Start by calculating the target price. The measuring technique is very simple. Start by calculating the height of the pattern. So, estimate the number of points vertically down from the top of the head to the neckline.

Deduct this number from the point where the price finally breaks the neckline, marking the end of the right shoulder.

That difference is the minimum target price.

The way you trade this pattern will depend on how aggressive you are. No matter what your character type, your trading focus will be on breaking the neck, saying so.

Remember, the pattern is not complete until the neckline is definitely broken by the right shoulder.

If you are confident that a head and shoulders formation is shaping up validly, that you should sell your stock once the right shoulder forms.

Sometimes, there’s no need to wait for a confirmed breakout before entering the trading field.

But it is highly advised, keep a close eye on the “return move.” Sometimes, after the neckline is broken on the right shoulder, the pattern leaps back up to the neckline. This is called a return move. The return move is often only a minor and temporary leap. If the neckline is broken on a huge volume, this diminishes the possibility that there will even by a return move. But, if the price keeps floating around the neckline without a definitive break, it may not be the head and shoulders reversal and the uptrend may continue.

Quiz yourself about Head and Shoulders Top indicator in the following quiz:

When unsure what's the right move, you can always trade Forex

Get the number #1 winning technical analysis ebook for trading Forex to your email.
Containing the full system rules and unique cash-making strategies. You'll be surprised to see what indicators are being used and what is the master tuning for successful trades. Including case-studies and images.
You have 5 seconds to decide!

FREE (PDF) Download:
Price Action Trading Blueprint

Traders-Paradise