The head and shoulders pattern is generally regarded as a reversal pattern
and it is most often seen in uptrends. It is also most reliable when found
in an uptrend as well. Eventually, the market begins to slow down and the
forces of supply and demand are generally considered in balance. Sellers
come in at the highs (left shoulder) and the downside is probed (beginning
neckline.) Buyers soon return to the market and ultimately push through
to new highs (head.) However, the new highs are quickly turned back and the
downside is tested again (continuing neckline.) Tentative buying
re-emerges and the market rallies once more, but fails to take out the previous
high. (This last top is considered the right shoulder.) Buying dries
up and the market tests the downside yet again. Your trendline for this pattern
should be drawn from the beginning neckline to the continuing neckline.
(Volume has a greater importance in the head and shoulders pattern
in comparison to other patterns. Volume generally follows the price
higher on the left shoulder. However, the head is formed on diminished volume
indicating the buyers aren't as aggressive as they once were. And on
the last rallying attempt-the left shoulder-volume is even lighter than on
the head, signaling that the buyers may have exhausted themselves.) New
selling comes in and previous buyers get out. The pattern is complete
when the market breaks the neckline. (Volume should increase on the
breakout.) (Chart examples
of head and shoulders patterns using commodity charts.) (Stock
charts.)
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