Head and Shoulders (Top
Reversal)
A Head and
Shoulders (Top) reversal pattern completion
marks a trend reversal. The pattern contains three successive peaks with the
middle peak (head) being the highest and the two outside peaks (shoulders)
being low and roughly equal. The reaction lows of each peak can be connected to
form support, or a neckline
As its name implies, the head and shoulders reversal pattern is made up
of a left shoulder, head, right shoulder, and neckline. Other parts playing a
role in the pattern are volume, the breakout, price target and support turned
resistance. Lets look at each part individually, and then put them together
with some example
1. Prior Trend: It is important to
establish the existence of a prior uptrend for this to be a reversal pattern.
Without a prior uptrend to reverse, there cannot be a head and shoulders reversal
pattern, or any reversal pattern for that matter.
2. Left Shoulder: While in an uptrend, the
left shoulder forms a peak that marks the high
point of the current trend. After making this peak, a
decline ensues to complete the formation of the shoulder (1). The low of the
decline usually remains above the trendline, keeping the uptrend intact.
3. Head: From the low of the left shoulder, an advance
begins that exceeds the previous high and marks the top of the head. After
peaking, the low of the subsequent decline marks the second point of the
neckline (2). The low of the decline usually breaks the uptrend line, putting
the uptrend in jeopardy.
4. Right Shoulder: The advance from the low
of the head forms the right shoulder. This peak is lower than the head (a lower
high) and usually in line with the high of the left shoulder. While symmetry is
preferred, sometimes the shoulders can be out of whack. The decline from the
peak of the right shoulder should break the neckline.
5. Neckline: The neckline forms by connecting low points 1 and
2. Low point 1 marks the end of the left shoulder and the beginning of the
head. Low point 2 marks the end of the head and the beginning of the right
shoulder. Depending on the relationship between the two low points, the
neckline can slope up, slope down or be horizontal. The slope of the neckline
will affect the pattern's degree of bearishness: a downward slope is more
bearish than an upward slope. Sometimes more than one low point can be used to
form the neckline.
6. Volume: As the head and shoulders pattern unfolds, volume
plays an important role in confirmation. Volume can be measured as an indicator
(OBV, Chaikin Money Flow) or simply by analyzing volume levels. Ideally, but
not always, volume during the advance of the left shoulder should be higher
than during the advance of the head. These decreases in volume along with new
highs that form the head serve as a warning sign. The next warning sign comes
when volume increases on the decline from the peak of the head. Final
confirmation comes when volume further increases during the decline of the
right shoulder.
7. Neckline Break: The head and shoulders
pattern is not complete and uptrend is not reversed until neckline support is
broken. Ideally, this should also occur in a convincing manner with an
expansion in volume.
8. Support Turned Resistance: Once support
is broken, it is common for this same support level to turn into resistance.
Sometimes, but certainly not always, the price will return to the support
break, and offer a second chance to sell.
9. Price Target: After breaking neckline
support, the projected price decline is found by measuring the distance from
the neckline to the top of the head. This distance is then subtracted from the
neckline to reach a price target. Any price target should serve as a rough
guide, and other factors should be considered as well. These factors might
include previous support levels, Fibonacci retracements, or long-term moving
averages.
No comments:
Post a Comment