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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. |
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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.
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| 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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