Head and Shoulders pattern

Head and Shoulders pattern – Trend Reversal Pattern

I) Regular Head and Shoulders Pattern

Bearish, reversal pattern signaling the end of the current uptrend
Basically looks like the silhouette of a human left shoulder, head, and the right shoulder.
reversal pattern
Like the Double Top, strong volume push prices upwards forming the “left shoulder”. The pullback is on lesser volume, then another strong rally on good volume, forming the “head” … but this time, the volume causing this rally although forming higher prices, is now on relatively lower volume as compared to the vol. in the rally causing the left shoulder … as the stock pulls back to the neckline and starts rallying again to form the right shoulder, now volume is very noticeably lighter the break of the neckline confirms the H & S pattern (Neckline is the line connecting the two troughs on either side of the head).
Volume expansion is noticed as the pattern confirmation takes place … and the stock or index is now in a downtrend. (Reverse happens now … vol. expands on the downfall and decreases on a return move up)
Trading-Wise -> ENTRY

The first down day below the neckline confirms the pattern…….short as the neckline breaks or enter short on a weak rally back to the area of the neckline.This line that was formerly strong support now acts as a stiff resistance.Short half on that return move, and the other half below the low of the confirmatory bar.

TARGET
The first target would be … calculate the difference from the head to the neckline.Add that to the low of the bar that confirmed the pattern.
STOP
The high of the right shoulder.
One Important Condition
Once the neckline gets broken, expect a return move … but at all costs the price should not re-break the neckline upwards. If this happens, it is called a FAILED H&S PATTERN. Like a failed breakdown, this acts as a bear trap and is bullish. So get out if that neckline gets broken back upwards.

II) Inverse Head and Shoulders Pattern

– Reverse of the above
– Reversal pattern that ends a downtrend
– Trade-wise, all reverse of above
reversal pattern

Volume and H & S

Volume plays an important role in us calling a particular pattern a H&S. Let us go through the Volume bit.

When the left shoulder is made, in both the h&s and inverted h&s, expect strong volumes. When the head is made, it is on (usually) decreased volumes as compared to the left shoulder. But as Rahul pointed out a key difference, the rt shoulder on a h&s is on usually lower volumes. Volumes increase when necklines break, and patterns get confirmed. And as all breakdown patterns, a break below support is accompanied by strong volumes and then the return rally to what is now resistance is on low volumes, followed by strong volumes again, bringing the stock to newer lows.
But, in the Inverted H & S, once again, we have strong volumes in the forming of the lt shoulder. Again, we have decreased volumes in the forming of the Head. But, here, we have increased volumes taking prices back to the neckline, then a dip in volume as the stk tries to make the right shoulder, and then a burst in volume taking it through the neckline.

Summarizing H&S

Left shoulder   : Strong volumes
Head               : Lighter volumes
Right shoulder : Same as or lighter than the head.
*** Increase in volumes as neckline breaks to the downside.

Summarizing Inverted H&S

Left shoulder   : Strong volumes
Head               : Lighter volumes
*** Increase in volumes, sometimes higher than before the formation of left shoulder
Right shoulder             : Dip in volumes from the rally
Once again, an increase in volumes breaking the stk out over the neckline.
An important thing to remember is that markets or stocks do not need strong volumes for the breakdown from the h&s as it basically falls with its own weight, but you need strong volumes for a breakout from an Inverted h&s.
NOTE : For head & shoulders to occur , we need a prior trend needed for reversal pattern which is uptrend, h&s is incomplete till neckline is broken, neckline break with large volumes confirm it.The support break indicates a new willingness to sell at lower prices. Lower prices combined with an increase in volume indicate an increase in supply. The combination can be lethal, and sometimes, there is no second chance return to the support break.

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