The purpose of this Market Call section is to
educate readers in technical analysis patterns and indicators. As with all investment
information, you need to research information and consult your financial advisor before
initiating any strategies that are contained in Market Call.
Also, you must realize that as with all trading strategies,
opinions can change quickly depending on market conditions and developments.
This column tries to present historical examples, potential set
ups, and examples of entry and exit strategies.
The Head and Shoulders Pattern
The head and shoulders pattern is generally regarded as a reversal pattern
and it is most often seen in uptrends.
It is also most reliable when found in an uptrend as well. Eventually, the
market begins to slow down and the forces of
supply and demand are generally considered in balance. Sellers come in at
the highs (left shoulder) and the downside is
probed (beginning neckline.) Buyers soon return to the market and
ultimately push through to new highs (head.) However,
the new highs are quickly turned back and the downside is tested again
(continuing neckline.) Tentative buying re-emerges
and the market rallies once more, but fails to take out the previous high.
(This last top is considered the right shoulder.)
Buying dries up and the market tests the downside yet again.
Your
trendline for this pattern should be drawn from the
beginning neckline to the continuing neckline. (Volume has a greater
importance in the head and shoulders pattern in
comparison to other patterns. Volume generally follows the price higher on
the left shoulder. However, the head is
formed on diminished volume indicating the buyers aren't as aggressive as
they once were. And on the last rallying
attempt-the left shoulder-volume is even lighter than on the head,
signaling that the buyers may have exhausted themselves.)
New selling comes in and previous buyers get out. The pattern is complete
when the market breaks the neckline. (Volume should
increase on the breakout.)
A reverse Head and Shoulder formation occurs with a mirror formation with
the head the low and the shoulders the higher highs on both sides.
This pattern can be used on charts of various time frames from minutes to
daily or even weekly charts.
Our charts are 60 minute charts.
Let’s look at a Reverse Head and Shoulders in BMC Software (NASDAQ:
BMCS).
A Reverse Head and Shoulders Pattern:
A major reversal pattern with four
distinct features:
Left Shoulder:
A high volume drop, which occurred after
earnings warning on January 5 with, follow through on January 6, 2000.
Head:
Another high volume drop with the bottom
reaching a lower 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. This is the action on January 7, 2000.
Right Shoulder:
A third rally on noticeably less volume
that exceeds the top of the head. This is the action we saw today.
Neckline:
This would be drawn across the resistance
at 47 7/8 and today’s high of 46 5/8.
If BMCS can take out today’s high of 46 5/8, a completion of this reverse
head and shoulder formation would be complete.
I would enter with a Buy Stop at 48 � Buy Stop.
If filled, I would place a stop at 44 �.
If the stock does not break above 48 �, do not take the trade.
