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 “head” to appear, will give you the chance to profit from this market trend before it turns bear. This will provide you with a significant advantage over other investors that might not be able to predict an oncoming downturn in time.
Understanding the Head and Shoulders Top Pattern
The head and shoulders top pattern takes shape when a stock or index is price rises to a peak and then suddenly declines back to the base of the prior move. It will then rise above the former peak to form the head, and then once again drop back to the base level. Then, in a final move, the stock or index will rise again, but to only the level of the first peak of the formation, here is where it will travel back down to the baseline for the final time.
Is here the support breaks indicating a new willingness for the stock or index to sell to lower prices. This decrease in price, along with an increase in volume indicates an increase in supply. This fierce combination can trigger a powerful downward move that eliminates any chance of the stock returning to the previous support level.
- Pattern type: Reversal
- Indication: Bearish
- Breakout confirmation: The confirmation for this pattern is when there is a close below the lower trendline drawn horizontally across the intervening low with above-average volume.
- Measuring: Take the distance between the first low to the top of the head, then subtract that amount from the neckline on the breakout.
- Volume: The volume increases during the upward formation of the initial shoulder, then diminishing as the price drops exiting the left shoulder. The volume will then balance out during the creation of the head, only to increases again as the price breaks down below the bottom support level.
The head and shoulders top pattern is one of the most recognizable technical charts. The left and right shoulders should be roughly the same height and width, but they may be slightly staggered. It’s important to understand that the pattern occurs after an uptrend and usually marks a significant reversal in the stock or index. Identifying the neckline and volume on the brake is essential to confirm that pattern. To learn more about stock chart patterns and how to take advantage of technical analysis to the fullest, be sure to check out our entire library of predictable chart patterns. These include comprehensive descriptions and images so that you can recognize important chart patterns scenarios and become a better trader.