We have been looking at some Head and Shoulder patterns this week.
I wanted to bring to your attention another example of a stock breaking down
from a Head and Shoulder pattern.
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.)
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.
This example of another breakdown is in Applied Materials (NASDAQ:
AMAT).
This is a broader Head and Shoulders than we saw in previous examples.
Head and Shoulders Pattern:
A major reversal pattern with four distinct features:
Left Shoulder:
The left shoulder is the May 3 and May 4 time frame.
Head:
A rally on climaxing on May 5 is the head.
Right Shoulder:
The stock formed a right shoulder on May 9 coming down to the support of May
3.
Neckline:
The neckline is the support drawn across the 90 price support area.
Today, May 10, 2000, AMAT broke below this neckline at 90 and continued
lower all day.
After the close, more bad news hit AMAT.
Look for these patterns and plan your exit before the bad news and major
declines begin.
