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 Vitesse Semiconductor
(NASDAQ: VTSS).
A Reverse Head and Shoulders Pattern:
A major reversal pattern with four distinct features:
Left Shoulder:
This would be the time that VTSS spent on May 22 and 23.
Head:
This is the drop in price on May 24.
Right Shoulder:
A rally on May 25 and 26 brought VTSS to an area where it formed the right
shoulder.
Neckline:
This would be drawn across the resistance at 48.
Today, May 30, 2000, VTSS opened at 47 � and broke the neckline and moved
higher all day.
I expect VTSS to continue to rally from here and would place a stop at 49 if
bought in the morning.
There are many stocks exhibiting this pattern. Look for stocks breaking out
from a neckline resistance.
