Head and Shoulders pattern
A Wealth of Knowledge
The head-and-shoulder’s pattern is one of the most reliable and well-known chart formations. It consists of three consecutive rallies. The first and third rallies have approximately the same height. Whereas, the middle rally is the highest of all (being the "head"). All three rallies are based on the same lateral support line or a resistance line (in the case of an inverse head-and-shoulders pattern), known as the neckline. So, should the market break the neckline (being support or resistance), this then triggers a head and shoulders pattern.
So a head and shoulders pattern is a trend reversal formation, which is characterized by the market making a small rally followed by a big rally (high and a higher high). Then upon this happening, the market will rally once more, but this time making a small rally as was the case with the first one. The last rally is basically of the same height as the first rally. These rallies are referred to as the shoulders. These two rallies are basically separated by a big rally (called a "head"). Why is this? because it is bigger than both the previous and the following rally whereas the two rallies on either side of that move are around the same price level giving the impression of a head and shoulders.
Such a formation usually forms when the market is to reverse, from either an uptrend to a downtrend or downtrend to an uptrend in the case of an inverse head and shoulders pattern. So, in a normal head and shoulders pattern the market will make three rallies then supported by a lateral supported line. The support (neckline) will only break when there is a lot of selling volume on that market. So, the break of that neckline is signaling that there is far greater selling volume. So, this then triggers a head and shoulders formation. Now, the question is how does one trade a head and shoulders pattern, upon the market breaking a neckline the logic is that it is going to come back to retest the neckline, which was once a support level but now being broken it has turned into a resistance.
Upon the market breaking the neckline, it has to rally towards the broken neckline/support to trigger a head and shoulders trade. So should such a phenomenon happen, then one is to start looking for candlestick patterns. Precisely bearish reversal candlestick or bullish reversal patterns in the case of an inverse head and shoulders.
blog comments powered by Disqus