Head and Shoulders Pattern
Takeaways
- A head and shoulders top is formed in an uptrend, indicating a bullish-to-bearish reversal.
- A head and shoulders bottom, also known as an inverse head and shoulders, is formed in a downtrend indicating a bearish-to-bullish reversal.
- You can read pattern signals in a chart by enabling ‘Technical Signals’ in ‘Chart Toolbox’.
- If you don’t know which stock to trade, you can screen stocks with a head and shoulders pattern.
What is the head and shoulders pattern?
The head and shoulders pattern looks like a human head with shoulders on both sides. It could be considered a bullish or bearish signal depending on its position. If it is formed at the top, it’s called the head and shoulders top, and is a bearish signal. If it is formed at the bottom, it’s called the head and shoulders bottom, and is a bullish signal.
Head and shoulders top
What does it look like?
A head and shoulders top is formed in an uptrend.It has three important elements, left shoulder, head, and right shoulder.
- The left shoulder occurs as the stock price hits a high in a rising market and then falls back.
- The head occurs when prices rise to a higher high and then fall back again.
- The right shoulder occurs when prices rise again but don’t hit the high of the head.
A neckline can be drawn by connecting the two lows in the pattern, serving as the support line.
How do you trade the pattern?
- Implications
A complete head and shoulders top pattern is believed to be formed when the stock price closes below the neckline. It’s a bearish signal indicating that the stock price will reverse to the downside.
- Entry point
Investors often consider the breakout (the point when the support line is broken) as an entry point. They would place a short sale at this point. Others may choose to exit a long position at the breakout.
- Profit target
The profit target for the pattern is the price difference between the head and the low point of either shoulder. In the example below, it’s estimated that the stock price would drop as low as $404,073-$398,258 (target price). (Slide to the bottom to see how to check automatic pattern signals.)
Investors may want to estimate their potential profits before placing a trade near the breakout. They may also place a stop order according to the target price to secure profits or stop losses.
Head and shoulders bottom
What does it look like?
A head and shoulders bottom pattern is a top pattern upside down. It is formed in a downtrend.
As shown below, a neckline can be drawn by connecting the two highs in the pattern, serving as the resistance line.
How do you trade the pattern?
- Implications
A head and shoulder bottom is the opposite of the top pattern described above. It is a bullish signal indicating that the stock price will reverse to the upside.
- Entry point
Breakout happens when the resistance is broken. Investors may choose to buy the shares at this point. Others may choose to close a short position at the breakout.
- Profit target
The profit target for the pattern is the price difference between the head and the high point of either shoulder. As the green shadow shows below, it’s estimated that the stock price may rise as high as $328-$335.
Automatic pattern signals in ‘Technical Signals’
A standard head and shoulder pattern is uncommon in the real world. There are various pattern formations that count as a head and shoulders pattern. Enable ‘Technical Signals’ in ‘Chart Toolbox’>’Settings’ to read automatic pattern signals in a chart.
Head and shoulders pattern in ‘Screener’
If you’re eager to trade the pattern but not sure which stock to trade, use our Screener to find one.
*Note: The pattern signals are not 100% accurate. Use other technical analysis methods, such as support and resistance or MA to confirm a price reversal.
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