Head and Shoulders Pattern
The head and shoulder formation is the best indication for a trend change. The head and shoulder reversal pattern forms at the end of an uptrend, and its completion marks a trend reversal. Thus, head and shoulders patterns are top reversal patterns.
The pattern comprises of three peaks with the middle peak (head) being the highest, and the two flanking peaks (shoulders) being lower and roughly equal. The reaction lows of each peak can be connected to form a support line, called the neckline.
As its name implies, this pattern resembles the upper portion of a human torso and is made up of a left shoulder, a head, a right shoulder and a neckline. Other parts playing a role in the pattern are volume, the breakout, price target and support turned resistance.
The left shoulder is formed after an extensive increase in price, usually supported by high volume. This is the first peak of the ongoing uptrend.
After making this peak, the price dips slightly, usually on lower volume, to complete the formation of the shoulder. This dip is the start of the neckline and the head is about to form.
The head is formed with heavy volume on the rising side of the head, and lower volume on the falling side. Prices then fall to somewhere near the same level as the low of the left shoulder.
The right shoulder is formed by a rally in the price to a level roughly equal to that of the left shoulder. Again it can be slightly higher or lower but it must definitely be below the high achieved by the head.
The decline from the peak of the right shoulder should then break the neckline.
The neckline can be drawn by connecting both the lower points of left and right shoulders. The neckline can slope up, slope down, or even be horizontal.
The slope of the neckline will affect the pattern’s degree of bearishness; a downward slope is more bearish than an uptrend slope.
Sometimes more than one low point can be used to form the neckline. Once the right shoulder has started to form you can draw in a neckline across the bottoms created between the left shoulder and the head, and the head and right shoulder. When the price falls from the right shoulders top formation is confirmed and it is your signal to go short or sell the stock.
The head and shoulders pattern is not complete, and an uptrend is not reversed, until the neckline support is broken.
One of the important habits you must develop is to learn to look at volumes accompanying the various chart patterns. You must always pay attention to this critical and important factor to avoid being fooled by the market and the price chart.
Lupin Made a left shoulder in November 2019 with high volume. it again peaked to a high of Rs. 815 , thus marking a head . Lupin made the right shoulder in in Jan 2020. Note the low volumes during the formation of the right shoulder.