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Head and shoulders pattern

Additional Resources

  1. Open Yale Courses [oyc.yale.edu]
  2. Lecture 11 [oyc.yale.edu]
  3. Economics 252 – Financial Markets Spring 2011 Lecture 6: Efficient ... [oyc.yale.edu]
  4. Technical Indicators And Charting Patterns [pages.stern.nyu.edu]
  5. Foundations Of Technical Analysis [web.mit.edu]
  6. The Dreaded Head & Shoulder (2016) [business.baylor.edu]

Head and shoulders pattern

In the financial market, technical analyst makes use of a head and shoulders pattern that is regarded, or sometimes called the reversal pattern. It is quite common and is most reliable in the uptrends. With time, the market begins to decline, while the factors and forces for demand and supply are in balance.

Traits of the Head and Shoulders Pattern:

  • A high point, a head in between the shoulders.
  • 2 shoulders.
  • The pattern should be confirmed by the volume.

The shoulders are where the sellers enter at the highs, and the beginning of the neckline is where the downside is explored. When this happens, buyers reenter the market and push to new highs which is referred to as head. But due to the continuing neckline, these new highs are inverted. The unsettled buying awakens once again with market rallies, but this does not take out the old high.

The buying trend dries up at one point. Hence, the declining market emerges again.

Characteristics of the Head and Shoulders Pattern:

  • The head and shoulder, most of the times are imperfectly shaped.
  • The formation is always tilted either upwards (top) or downwards (bottom)
  • On various patterns of the chart, either of the shoulders will appear to be broader in look and size than other. This is caused due to the time that is taken in the valley’s development.
  • The neckline can be either ascending or descending. It will never be perfect.

Head and shoulder pattern: Why are they important?

Neckline is a key feature of the head and shoulder pattern. It is formed by drawing a line by the connection of two price points that are lowest. According to technical analysts, the head and shoulder pattern is not efficient if the prices are not below the neckline, which is horizontal in shape.

Therefore, the market rally does not pass through the regular neckline level. So before selling hits, the deep downfall occurs and the prices go down in large volumes. This pattern is deemed as the most reliable (reversal) pattern of all.