Chart Patterns: Head and Shoulders

The head and shoulders pattern is one of the most reliable reversal patterns in technical analysis. It signals the end of an uptrend and the beginning of a downtrend. [DEFINITION] Head and Shoulders: A reversal pattern with three peaks—a higher middle peak (head) flanked by two lower peaks (shoulders)—indicating a trend change from bullish to bearish. ### Pattern Anatomy **Left Shoulder:** First peak, formed during uptrend **Head:** Higher peak, trend seems strong **Right Shoulder:** Lower peak, can't reach head height **Neckline:** Support line connecting the lows between peaks [EXAMPLE] Stock rises to $100 (left shoulder), pulls back to $90, rallies to $110 (head), drops to $90 again, rallies only to $100 (right shoulder), then breaks below $90 (neckline). Pattern complete. ### Trading the Pattern **Entry:** Short when price breaks below neckline with volume **Stop-loss:** Above the right shoulder **Target:** Distance from head to neckline, projected down from breakout [FORMULA] Price Target = Neckline - (Head Price - Neckline) [EXAMPLE] If head is at $110, neckline at $90: Target = $90 - ($110 - $90) = $90 - $20 = $70 ### Confirmation Signals [TIP] Wait for the neckline break before trading. The pattern isn't complete until price closes below the neckline, preferably with above-average volume. **Strongest patterns have:** - Clear symmetry between shoulders - Volume declining from left shoulder to head to right shoulder - High volume on neckline break - Clean, horizontal or slightly upward-sloping neckline ### Inverse Head and Shoulders The bullish version forms at market bottoms: - Three troughs instead of three peaks - Head is lowest, shoulders higher - Signals end of downtrend - Trade the upside breakout above neckline [WARNING] Not every three-peak pattern is a head and shoulders. The pattern requires a preceding uptrend (for bearish H&S) or downtrend (for inverse H&S). Without context, the pattern loses significance. [EXERCISE] You identify a potential head and shoulders with left shoulder at $50, head at $60, right shoulder at $52, and neckline at $45. The neckline just broke. What's your price target? |ANSWER| Target = $45 - ($60 - $45) = $45 - $15 = $30. The measured move projects a decline equal to the pattern's height. [KEY] Head and shoulders patterns on weekly charts are more significant than daily charts. Larger time frame patterns lead to larger price moves. [SCENARIO] You see a potential head and shoulders forming, but the right shoulder rises higher than the left shoulder. Is this still valid? Possibly, but it's less ideal. The pattern works because each rally shows diminishing strength. A higher right shoulder suggests buyers are still active, making the pattern less reliable. Wait for clear neckline break with volume before acting.