What does a Head and Shoulders pattern mean?

 

Technical analysis uses something called a "head and shoulders pattern." It is a pattern on a chart that shows a change from a trend that is going up to a trend that is going down. The pattern looks like a line with three peaks, two of which are about the same height and one in the middle that is the highest.

When the price of a stock goes up to a peak and then back down to where it started going up, this is called the "head and shoulders" pattern. The price then goes up above the previous peak, making the "head," and then goes back down to the original base. Lastly, the stock price goes up to about the same level as the first peak of the formation before going back down.

People think that the head and shoulders pattern is one of the best ways to figure out when a trend will change. It is one of a few top patterns that show, to a greater or lesser extent, that a rising trend is about to end.

How to Find the Head and Shoulders Pattern

A head and shoulders pattern has four parts:

After going up for a long time, the price reaches a peak and then falls to a trough.

The price goes up again, reaching a second peak that is much higher than the first, and then it goes down again.

A third time, the price goes up, but only to the same level as the first peak. Then it starts to go back down.

The neckline, which runs between the two peaks or valleys (inverse).

The top two peaks are the shoulders, and the top peak in the middle is the head. Between the first and second troughs is the neckline.

Head and Shoulders Backwards

The opposite of a head and shoulders chart is an inverse shouldershead and shoulders chart, also called a head and shoulders bottom. It's the opposite of the head-and-shoulders bottom, which is used to predict a change in a downtrend. This pattern can be seen in the price of a security when the following things happen:

The price goes down, then back up again.

The price goes down below the previous low, and then it goes back up.

The price goes down again, but not as far as the second trough.

Once the last trough is made, the price goes up toward the resistance (the neckline), which is near the top of the previous troughs.

What can you learn from looking at the Head and Shoulders Pattern?

The head and shoulders pattern shows that there could be a change in direction. Traders think that the price of a stock will start to go down when it has three peaks and valleys with a larger peak in the middle. Traders who think the price will go down start selling at the neckline.

The pattern also shows that the new downward trend is likely to continue until the right shoulder is broken. This happens when prices move higher than the prices at the right peak.