head and shoulder stock chart pattern

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Head and Shoulders

head and shoulders patterns resemble the upper part of a person's body, specifically a shoulder on either side of a head. The line connecting the left and right armpit is referred to as the neckline.After a rise in the market, if a formation that looks like a head and shoulders is forming and price breaks through the neckline after completing the right shoulder, this indicates a possibility that a reversal of the price trend may occur.

A head and shoulders pattern can also occur at the market bottom. When it is at a bottom the formation is inverted, like someone upside down. Volume is usually highest during the left shoulder formation. As prices slip back, volume recedes, when a second rally forms, volume is again high, the head of the pattern is formed when surging prices and volumes begin to ease and fall back again. The trough between the head and the right shoulder must be below the peak of the left shoulder for the pattern to be considered a head and shoulder pattern.

The right shoulder is another rally in prices but typically volume is lower than the volume that created the left shoulder and the head. Once the head and shoulders formation is complete, a breakout down through the neckline can be a good indication that the trend of prices will continue in the direction of the breakout.

Price projections are identified by taking the point or percent change (dependent on the price of the security) between the Head and the Neckline. Then, that amount is projecting from the point of penetration of the neckline in the direction of the penetration after formation of the right shoulder. Price projections are only estimates and should accompany other supporting evidence in developing.

Sometimes head and shoulders patterns can be more apparent on indicators than in price action. The pattern is valid when it occurs on an indicator but does not mean a reversal of the price trend will necessarily occur. Momentum indicators like the MACD shown below can diverge from price for some time and so it is strongly recommended to wait for price reversal to occur before making trading decisions.

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