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.
Reverse Head and Shoulder Patterns are Bullish.
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
MRV Communications, MRVC.
A Reverse Head and Shoulders Pattern:
A major reversal pattern with four distinct features:
Left Shoulder:
This would be the time that MRVC had in the late June time frame.
Head:
This is the drop in price on July 6, 2000.
Right Shoulder:
The rally of July 7 and today July 10, 2000.
Neckline:
This would be drawn across the resistance at 70.
On Monday, MRVC opened up and moved toward the neckline all day.
I expect MRVC to continue to rally and if it takes out the neckline at 70
3/8 in the morning, I would Buy this Head and Shoulders pattern.
The Buy would be on a Buy stop at 70 3/8.
If filled, I would place a stop at 67 �.
Do not Buy the stock unless it breaks the neckline at 70 3/8.
