Chart Patterns
Head and Shoulders
Unlike continuation patterns, reversal patterns often can form over several weeks and in a wide trading range. Head and shoulder patterns are a type of reversal pattern and if correctly identified, can provide a trader a valuable insight into the movement of a security. Head and shoulder patterns are effectively an interpretation using peaks and troughs. A medium term up trend exists when a security is achieving higher peaks and higher troughs. In the chart below, you can see that the security has achieved higher peaks however then failed to achieve a higher peak.
At this point, there is a small amount of doubt about the strength of the medium term up trend. The key level at this stage is the line connecting the two troughs in between the peaks. If and when the security trades below this line, then the head and shoulder pattern has completed and a reversal is very likely. As the security is also on its way to achieving a lower trough after failing to achieving a higher peak, there is now enough doubt that the medium term up trend has ended. Support and resistance have a great influence on a security’s behaviour and this is especially the case with head and shoulder patterns. A head and shoulder pattern occurs when a security fails to break through resistance but simultaneously, the demand and support for the security subsides. An upside down head and shoulder pattern is the exact opposite of the head and shoulder pattern just described. It occurs when a security meets support and is unable to break through. The head and shoulder pattern is complete when the security moves above the line connecting the two peaks between the troughs.
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