A head and shoulders top pattern is one that has three peaks and looks like a head and shoulders because the two outside peaks are similar in height, yet shorter than the peak in the middle. This pattern is typically associated with a trend reversal from bullish to bearish, and is considered to be very reliable in its ability to predict this type of stock action. This pattern is one of several top patterns used in predicting the end of a bull run and the beginning of a downturn.
This head and shoulders top pattern happens when a stock rises to its peak and then drops back down to the point preceding the move upward. Then the stock will once again move upward, but this time it will surpass the prior spike and form what is called the “nose,” and then it will once again move back down to the point preceding the upswing. Once again, there will be an upward tick that reaches about the same level at the first spike with a subsequent fall back downward. This last downward tick is usually significant because it is at this point where the bull turns to bear.
If you become very good at reading this pattern, you can immediately see the advantage an investor can have. Selling your stock at the point where the “nose” has reached its peak would be an excellent idea, especially if you bought your stock at one of those points at the base of the pattern. Buying at the bottom, then waiting for the “nose” to appear will give you the chance to profit from this market trend before it turns bear, and that will provide you with a significant advantage over other investors that might not be able to predict an oncoming downturn in time.