Head & Shoulders Chart Pattern
There are 2 types of Head & Shoulder chart patterns, a regular Head & Shoulders chart pattern and an inverse Head & Shoulders chart pattern.
A regular Head & Shoulders chart pattern is a bearish reversal chart pattern and is most commonly develops at the end of an uptrend. An Inverse Head & Shoulders chart pattern is a bullish reversal chart pattern It most commonly develops at the end of a downtrend.
This page will focus on the regular Head & Shoulders chart pattern. This is the more common of the 2 types anyways.
Requirements
Characteristics & Observations
Breakout Area
Trading Strategies
Real Chart Examples
Regular Head & Shoulders Chart Pattern
Regular Head & Shoulder Chart Patterns form at the end of a stock’s rally and indicate that the rally is over. That is exactly what happened on the next stock which was a market darling for several years – Apple (AAPL).
The highs of over $700 that Apple hit in September 2012 formed the “head” in the Head & Shoulders pattern, then Apple began a nasty decline. At the end of the initial decline, it had dropped as low as $500, and then it bounced; this bounce created the right shoulder of the pattern. Take a close up view of the pattern below on a 1 year daily candlestick chart.
After bouncing off the neckline the first time to form the right shoulder, Apple again re-tested the neckline and closed below it on heavier than normal volume, as seen on the next chart below.
After the single close below the neckline, Apple then proceeded to climb and retake the neckline with 4 successive closes above it, but it did so on declining volume.
Closes above or below the neckline could indicate further short-term movements in the share price. You want to see a volume confirmation in the direction of the move.
Inverse Head & Shoulders Chart Pattern
An inverse Head & Shoulders Chart Pattern normally forms at the end of a stock’s downtrend. The stock tries to find a bottom by establishing the first shoulder. Then one of the final waves of sellers come in and push the share price to new lows, forming the head. At this point, buyers step in and the share price moves up, starting to form the right shoulder.
A classic head & shoulders inverse pattern can be seen in the next chart for Ford Motor Company (F).
A close above the neckline on the above chart would confirm a breakout for this pattern. As in most cases, a breakout on above average volume is preferred since this adds conviction to the breakout.
When Ford’s share price rose above the neckline as seen on the next chart below, the volume was the highest volume that had traded in the stock for the last several months, indicating that the share price was breaking out with conviction.
After Ford broke above the neckline, it did a throwback move to re-test the neckline before continuing its advance.
The throw-back move is an excellent time to add-on to your position taken on the breakout, or to initiate a position if you missed the breakout. Watch the share price and make certain that it continues to hold above the neckline when re-testing it. A single close below the neckline is typically no need for concern, especially if the close was on light volume.
When a stock breaks out of any pattern with such a conviction of volume, take special note of that stock as it may tend to outperform other stocks during the same period. Ford’s breakout with conviction from the inverse head & shoulders pattern ended up handing over some big gains to its investors, as seen on the next chart.
Remember, when a stock breaks out of a pattern with conviction, expand your outlook for the stock as it tends to outperform most other stocks during the same period.
