The head and shoulders pattern is a bearish reversal chart pattern. This pattern often hints of a top. If it appears in your stock it can be a warning to you to sell the stock or take some profits off the table.
This pattern is quite easy to spot.
It looks exactly like a human head with two shoulders.
The head and shoulders pattern is the opposite of the reverse head and shoulders pattern.
The chart above shows what a head and shoulders pattern looks like.
The pattern will have a left shoulder, then a head and then a right shoulder. The head represents the highest peak that the stock is able to make. The height of the left and right shoulders are almost the same.
In order to understand why this pattern works very well to spot a top, you need to understand the characteristics of a good uptrending stock.
A stock that is in a strong uptrend will continue to make higher highs and higher lows.
When you look at the head and shoulders pattern, the right shoulder is lower than the head. This tells us that price has failed to go above the head and therefore it has failed to make a new high.
This is cause for concern.
The head and shoulders pattern is deemed to start its work when it breaks below the neck line. The neck line is usually the lows of the pattern.
You can often find a target using the head and shoulders by taking the height of the head to the neck and then project that height downward from the neck line.
Stocks will often drop to that target or near that target. Sometimes a very bearish stock might shoot past the target.
If the head and shoulders break down is accompanied by a breaking of a trend line, then it reinforces the bearishness of the pattern. In the chart above, you can see how AAL broke below the chart pattern as well as an uptrend line.
The head and shoulders pattern also work very well in long term charts. Long term charts are the weekly charts and the monthly charts.
If this pattern appears in the weekly chart, it can often point to a nasty drastic drop in the stock. A healthy stock will be able to make higher highs and trend up in the weekly chart. The fact that the stock cannot make a new high but makes a right shoulder tells us this stock may be in trouble.
The chart above is the weekly chart of Salutica which is a Malaysian stock. Even in the weekly chart of a stock somewhere in South East Asia, you can see how chart patterns work so well to warn investors of the crash in the stock.
Salutica made a very big weekly head and shoulders pattern. The plunge in the stock started when it broke below the neckline of the weekly head and shoulders top. At this moment, the stock is bouncing up a bit as it hit the support area from the left.
The target still has some way to go before the stock reaches it. If the daily downtrend in the stock does not end, even the support will not hold and it is possible for Salutica to meet the weekly head and shoulders target.
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