Head & Shoulders Top

Head and Shoulders top

The Head and shoulders top formation is one of the most common and most reliable chart patterns. Head and shoulders top pattern has three distinct tops, there are : the highest top in the middle (Head) and lower tops (Shoulders) on either side of the head.

Head and shoulders top is a major reversal pattern with four distinct features :

Left shoulder: a high volume rally and top followed by a minor reaction with significantly less volume than during the rise and top.
Head: another high volume rally with the top reaching a higher level than the left shoulder, followed by a another reaction on less volume that takes the price to a level near the bottom of the previous reaction.
Right shoulder: a third rally on noticeably less volume that fails to reach the top of the head.
Neckline: a decline in prices from the top of the right shoulder which falls below the line formed when connecting the bottoms of the left shoulder and head by at least 2-3% of the stock’s market value.
Target: Usually, when a head and shoulders top occurs, the price difference from neckline to the top of the head is likely to be the target for the reverse.

The left shoulder is typically formed at the end of an extensive advance. After prices drop from the peak of the left shoulder, they rally to a new high and then decline to near the low of the left shoulder to form the head part of the head and shoulders top chart pattern. A final advance to a peak lower than that of the head followed by a decline in prices forms the right shoulder and completes the chart pattern.

A neckline can be drawn across the bottom of the left shoulder, head and right shoulder. When the neckline is broken, this is confirmation of a reversal in the trend. After moving lower, it is not uncommon for prices to pull back to the neckline before continuing their descent.

A SELL signal is given when the neckline is penetrated downward. From that point the estimated downside target is equal to the distance between the top of the head and the neckline.

Examples of Head and Shoulders Top:

Failed Head and Shoulders Top:

When a Head and Shoulders Top formation is failed, it is usually followed by a strong rally. This is because of the great change in the market sentiment. Failed Head and Shoulders Top usually followed by a consolidation pattern, like triangle, before a strong rally.