Trading Considerations: The Almighty Head And Shoulders Top Pattern PDF Print E-mail
Written by Chris Blanchet   
Saturday, 27 June 2009 11:22
The Head and Shoulders Top is considered one of the most popular and reliable pattern when it comes to technical analysis. The reason for its popularity has to do with how easily new and seasoned investors can recognize it. And the reason it is considered one of the most reliable classic patterns is that it seldom produces false positives.
by ChrisBlanchet


The Head and Shoulders Top is considered one of the most popular and reliable pattern when it comes to technical analysis. The reason for its popularity has to do with how easily new and seasoned investors can recognize it. And the reason it is considered one of the most reliable classic patterns is that it seldom produces false positives.

What a Head And Shoulders Top Looks Like Quite simply, the Head and Should Top pattern resembles a human. The head (the highest peak) has two shoulders on each side (smaller peaks). The patterns is formed when a rally experiences a pull-back, followed by another rally that reaches a higher high than the last, and then a third rally (the right shoulder) that reaches the same left as the first (left shoulder).

As far as technical analysis is concerned, the head and shoulders pattern also needs to meet a volume requirement. To prove the legitimacy of this pattern, the first rally (or left shoulder) should see heavier volume than the remaining rallies.

Technical Considerations Aside from the volume requirement and of course the visual appearance of the head and shoulders top, investors should consider that the two shoulder rallies will peak at the same price, or thereabouts. Another consideration would be the neckline (the line that can be drawn between the toughs following the first and second rallies). While necklines do not need to meet a particular criteria, when the neckline slopes upwards, the pattern is considered more bullish versus a flat or downward-sloping neckline (for strong, bearish trades seek downward sloping necklines).

Another key point is that the pattern should take shape above a comparable moving average (MA). Typically, the 50-day moving average will work just fine, but investors are advised to use the 200-day moving average for longer-term patterns. And speaking of Moving Averages, the MA should be trending in the same direction as the Head and Shoulders top. If it doesn't, then it simply means the pattern is less reliable.

Head and Shoulders-based Trading When making trades based on the head and shoulders pattern, investors should realize that the longer it takes for the pattern to unfold, the longer it will take for the price to drop down to its target. Likewise, in order to confirm this pattern, traders should consider the inbound trend. The inbound trend should last longer than the pattern's overall trend, otherwise it is quite likely that the pattern itself is simply indicating a period of consolidation and is not a true, bearish signal.

The head and shoulders pattern will form on hundreds of securities daily. The question is not whether the pattern exists, but the reliability and strength of the pattern and whether it is strong enough to trade. Given the knowledge needed to properly identify a head and shoulders top, beginning investors and people who demand a more hands-off approach will opt to use trading software and systems instead.

DISCLAIMER: This article is provided as information only and is not to be taken as financial advice.

With more than 16 years of experience as a Financial Advisor for one of the world's largest commercial banks, Chris Blanchet is responsible for the Free Technical Analysis Course at Online Trader Today.com. He also maintains a Debt-Free Blog at How To Repay Debt.com.