P.S. A special Emerging Markets report will be published tomorrow. So if you have read the article on Head and Shoulders, thank you for waiting. And if you have not read the following article on Head and Shoulders, it will be a good segway into next 3-4 articles on globals markets.
The left shoulder is formed at the end of an extensive move during which volume is noticeably high.
After the peak of the left shoulder is formed, there is a subsequent reaction and prices slide down to a certain extent which generally occurs on low volume.
The prices rally up to form the head with normal or heavy volume and subsequent reaction downward is accompanied with lesser volume.
The right shoulder is formed when prices move up again but remain below the central peak called the Head and fall down nearly equal to the first valley between the left shoulder and the head or at least below the peak of the left shoulder. Volume is lesser in the right shoulder formation compared to the left shoulder and the head formation.
A neckline is drawn across the bottoms of the left shoulder, the head and the right shoulder. When prices break through this neckline and keep on falling after forming the right shoulder, it is the ultimate confirmation of the completion of the Head and Shoulders Top formation. H&S necklines can be down sloping or up sloping, depending to the severity of the trend.
Neckline Break: The head and shoulders pattern is not complete and the uptrend is not reversed until neckline support is broken. Ideally, this should also occur in a convincing manner, with a high increase in volume.
Support Turned Resistance: Once support is broken, it is common for this same support level to turn into resistance. Sometimes, but certainly not always, the price will return to the support break, and offer a second chance to sell.
Price Target: After breaking neckline support, the projected price decline is found by measuring the distance from the neckline to the top of the head. This distance is then subtracted from the neckline to reach a price target. Any price target should serve as a rough guide.
HEAD & SHOULDERS - THE REALITY
- All H&S patterns do not result in sharp declines. If a pattern is
shorter in duration, it might just be a continuation pattern. On the other hand,
if the pattern is longer in duration, it would suggest a market top is at hand.
- H&S patterns graphically portray the distribution that takes place at market tops, from stronger hands to weaker hands. Throughout this pattern, prices remain in a tight range because both buyers and sellers fight out for the true price of the asset. Typically, people who owned the stock since the bottom want to sell their positions and lock in profits. Whereas, those who initially missed the boat want to buy in. Soon thereafter, all the buyers are exhausted from the market place and only sellers remain. This lack of demand pushes the market down to the next level of support because the volume needed to drive the stock prices higher is absent. As a result, the right shoulder is usually lower than the head. Finally, when the market comes back to the neckline for the 3rd time in the right shoulder, it breaks below the neckline. This break often results in a sharp decline of prices.