The ins and outs of the head and shoulders pattern
The head and shoulders pattern is a handy tool for spotting the end of an uptrend.
It has two main benefits, Frank Hemsley in Profit Watch explains.
It generates a clear sell signal; and
It show you how big the fall is likely to be.
Have a look at the chart below showing a head and shoulders pattern…
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The vital parts making up a head and shoulders pattern
There are five main stages in a head and shoulders pattern…
The first stage is when a strong rise in price stops then pulls back. The mini peak shape formed by this price movement is the left shoulder of the pattern.
The price then starts to rise again. It hits a new high (this must be higher than the peak from stage one). This peak is the head of the pattern.
The price then falls again, it may be a sharper fall as traders become more cautious, selling it down. It falls down to find support at the shoulder level from stage one.
The price rallies slightly but comes to an end before reaching the level of stage two. This gives you the right shoulder. From here you can draw in the neckline.
You draw the neckline from the bottom of the left shoulder to the bottom of the right shoulder. This line is very important as it tells you how far the price should fall.
After stage four, the price falls again and breaks through the support neckline, usually on heavy volume. You tend to find the fall from here will be the same size as the fall below the neckline when the support failed.
So there you have it. How to know it’s time to sell with a head and shoulders pattern.
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