Technical analysis II

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10. Head and shoulders top

The Head and Shoulders Top is one of the most common, and reliable, forms of reversal pattern. The shape consists of a left shoulder followed by a head and then a right shoulder.

A head and shoulders top

• The left shoulder is formed after an extensive increase in price, usually supported by high volume. The shoulder rounds as the price dips slightly, usually on lower volume. This dip is the start of the neck line and the head is about to form.
• The head is formed with heavy volume on the rising part of the head and less volume on the falling part. Prices then fall to somewhere near the same level as the low of the left shoulder. It does not have to be at exactly the same level and could be slightly higher or lower, but definitely below the top of the left shoulder.
• The right shoulder is formed by a rally in the price to a level roughly equal with that of the left shoulder. Again it can be slightly higher or lower but definitely below the high achieved by the head.

Once the right shoulder has started to form you can draw in a "neckline" across the bottoms created between the left shoulder and head and the head and right shoulder. When the price falls from the right shoulder and breaks through the neckline the Head and Shoulders Top formation has been confirmed and it is your signal to consider selling the share.

Note that the Head and Shoulders Top formation does not need to be perfectly symmetrical. The time taken to create each of the shoulders may be different. This will cause one shoulder to look slightly larger than the other even though it has reached a similar high point.

Also the neckline does not have to be exactly level and may slope up or down. This will make one of the shoulders look as though it is drooping or that the head is lopsided. It is important that the lowest point on the right shoulder must be lower than the highest point on the left shoulder, otherwise you may simply have an uptrend that is changing it's gradient.

1. Average share prices 2. Moving averages 3. Weighted moving averages 4. Where to plot moving averages 5. Interpreting moving averages - the basics 6. Classic interpretation of moving averages 7. Combining short and long term moving averages 8. Moving average convergence/divergence (MACD) 9. Reversal patterns 10. Head and shoulders top 11. Head and shoulders bottom 12. Double top 13. Double bottom 14. Rounding tops and bottoms 15. Broadening formations 16. Wedge formations 17. The momentum indicator 18. The momentum oscillator 19. Rate of change indicator 20. Price minus average 21. Relative strength indicator 22. Conclusion

• Martin Pring's Introduction to Technical Analysis
• Technical Analysis Plain and Simple
• Technical Analysis of the Financial Markets