What Is A Head And Shoulders Pattern?

Trade Like A Pro: Head And Shoulders Formation

Head And Shoulders Formation

As you might know, my top millionaire trading challenge students and I rely on predictable patterns to create our wealth and a head and shoulders chart pattern signifies a particular change in desirability for a stock or security. Have you ever wondered how Wall Street, or reputable traders, always seems to know ahead of time when a stock is about to go sideways, and gets out at just the right time? Or that they know just when to get in, before a stock surges?

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To a newer trader/investor, this can be puzzling, it not troubling, to always feel like you’re on the outside looking in.

Well, knowing chart patterns inside and out is key to your success so I HIGHLY recommend you watch my brand new guide that’s 50% off here for just a few more days since I just finished it (finally, whew!), and studying that can help you to play along with the big boys. It’s not clairvoyance, and it’s not magic. But it works for me more times than not, nonetheless.

The trend shifts from bullish to bearish to bullish in one of the most predictable volatility patterns in the world of Wall Street. Right afterwards, traders know that there’s a high degree of probability that the end of an upward trend is near.

The pattern usually occurs in three parts:

  1. An asset rides the bull to a relative peak, before falling to form a trough.
  2. Once the price reaches a bottom, it begins an upward motion again, peaking at a crest higher than the security’s previous one, but then falling again right afterwards.
  3. In its final act, the price rises to the level of the first peak and then declines again for a final time.

In the preceding description, the first and third peaks represent the relative shoulders, while the second one is bound at the neckline of the figurative human formed by the market activity.

It is called head and shoulders because it visually resembles a silhouette of a head and shoulders.

 

But this can be upside down, too. Sometimes a head and shoulders pattern can signal an upcoming bullish trend after a period of bearish activity. In this case, stock prices would reach three lows in a row, punctuated by short rallies. The lowest trough becomes the head, while the two adjacent troughs form shoulders.  Once the pattern is through, the true tendency of the stock takes dominance.

 

The head and shoulders pattern is a true testament to the tug of war that plays out in all open markets. In quantum physics, scientists say that either a particle’s mass or location can be known for certain at one point in time, but not both. The speed of transactions in today’s computer trading world works similarly. A price point moves quickly relative to the market forces acting upon it, especially if the related stock is popular amongst a niche market.

The first description of the head and shoulders pattern tracks the waning momentum of a previously bullish stock. Market bulls, who generally already have a stake in the success of the stock, increase their exposure to the security, pushing the stock’s value upwards in two consecutive price shocks. It is possible that other investors will buy into the higher valuation, putting in their money to further the future of a security that would have otherwise failed.

But if the head and shoulders pattern is allowed to continue through the second trough, the security’s demise is certain. Knowledgeable investors – the kind that newbie traders follow on twitter and on blogs – thrive on easily identifiable patterns to gain a following. They hawk the markets for clear head and shoulders patterns to share to their subscribers. On today’s Wall Street, these patterns rarely last beyond their second trough because of the thousands of experienced traders on the lookout for this trend.

A related fluctuation tracks a “triple top” phenomenon, which marks three consecutive price hikes, all at nearly the same level, indicating that buying interest is losing steam despite efforts by market movers to keep the stock desirable.

Necklines connect the pattern’s two troughs, which might be drawn at a slight angle, depending on the nitty gritty details of the stock at hand. The neckline works as a symbol of resistance that causes prices to “bounce” from the level of a previous trough (or crest, depending on whether or not an inverted head and shoulders pattern was occurring).

Moments of controlled volatility create the trend disturbances that make and break hit securities. Three bumps on a relatively stable upward trajectory indicate turbulence ahead, or at least nervousness on behalf of the key stakeholders watching the stock’s price in the most paranoid fashion.

More embarrassing versions of this trend reveal themselves in the descending tops pattern, where organized buys of a particular security cause prices to rush upwards temporarily, before continuing a downward trend. This repeats one, twice, and sometimes even three times before key investors give up on their bet and sell off their stakes.

Every security has its own struggle. If the price changes have to do with corporate performance, the stock price will fluctuate in lockstep with corporate filing dates and major speeches by the company’s leadership. But, if the changes relate to slights of hand on Wall Street, the numbers could change at the whim of key investors, whether or not their outlooks match performance figures published by the corporation’s public relations staff.

In the end, the head and shoulders chart pattern is just one of many, and charting is just one small part of an overall strategy that every successful trader must understand, and can hopefully take part in. See this free guide to better understand my 7 key indicators that I use daily.

Learning to identify this chart pattern, and what it will mean for the future of any given stock will allow you to capitalize on the same information that even the big boys on Wall Street use.

Leave a comment below and tell me your favorite chart pattern too, maybe it’s the morning panic pattern here that I love so much! And I love hearing what’s working best for everyone!

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