A Head and Shoulders (Top) is a reversal pattern which occurs following an extended uptrend forms and its completion marks a trend reversal. The pattern contains three successive peaks with the middle peak (head) being the highest and the two outside peaks (shoulders) being low and roughly equal. The reaction lows of each peak can be connected to form support, or a neckline

As its name implies, the head and shoulders reversal pattern is made up of a left shoulder, head, right shoulder, and neckline. Other parts playing a role in the pattern are volume, the breakout, price target and support turned resistance. Lets look at each part individually, and then put them together with some example

1. Prior trend: It is important to establish the existence of a prior uptrend for this to be a reversal pattern. Without a prior uptrend to reverse, there cannot be a head and shoulders reversal pattern, or any reversal pattern for that matter.

2. Left shoulder: While in an uptrend, the left shoulder forms a peak that marks the high point of the current trend. It is formed usually at the end of an extensive advance during which volume is quite heavy. At the end of the left shoulder there is usually a dip or recession which typically occurs on low volume.

3. Head: From the low of the left shoulder, an advance begins that exceeds the previous high and marks the top of the head. At this point, in order conform to proper form, prices must come down somewhere near the low of the left shoulder –somewhat lower perhaps or somewhat higher but in any case, below the top of the left shoulder.

4. Right shoulder: The right shoulder is formed when the low of the head advances again. The peak of the right shoulder is almost equal in height to that of the left shoulder but lower than the head. While symmetry is preferred, sometimes the shoulders can be out of whack. The decline from the peak of the right shoulder should break the neckline.

5. Neckline: A neckline can be drawn across the bottoms of the left shoulder, the head and the right shoulder. A breaking of this neckline on a decline from the right shoulder is the final confirmation and completes the head and shoulder formation.

6. Volume: As the head and shoulders pattern unfolds, volume plays an important role in confirmation. Volume can be measured as an indicator (OBV, Chaikin Money Flow) or simply by analyzing volume levels. Ideally, but not always, volume during the advance of the left shoulder should be higher than during the advance of the head. These decreases in volume along with new highs that form the head serve as a warning sign. The next warning sign comes when volume increases on the decline from the peak of the head. Final confirmation comes when volume further increases during the decline of the right shoulder.

7. Neckline break: The head and shoulders pattern is said to be complete only when the neckline support is broken. Ideally, this should also occur in a convincing manner with an expansion in volume.

8. Support turned resistance: Once support is broken, it is common for this same support level to turn into resistance. Sometimes, but certainly not always, the price will return to the support break, and offer a second chance to sell.

9. Price target: After breaking neckline support, the projected price decline is found by measuring the distance from the neckline to the top of the head. Price target is calculated by subtracting the above distance from the neckline. Any price target should serve as a rough guide, and other factors such as previous support levels should be considered as well.

Signals generated by head and shoulder pattern

• The support line is based on points B and C.
• The resistance line. After giving in at point D, the market may retest the neckline at point E.
• The price direction. If the neckline holds the buying pressure at point E, then the formation provides information regarding the price direction: diametrically opposed to the direction of the head-and-shoulders (bearish).
• The price target D to F. This is provided by the confirmation of the formation (by breaking through the neckline under heavy trading volume). This is equal to the range from top of the head to neckline.

Volume study

Some important points to remember
• The head and shoulders pattern is one of the most common reversal formations. It occurs after an uptrend and usually marks a major trend reversal when complete.
• It is preferable that the left and right shoulders be symmetrical, it is not an absolute requirement. They can be different widths as well as different heights.
• Volume support and neckline support identification are considered to be the most critical factors. The support break indicates a new willingness to sell at lower prices. There is an increase in supply combined with lower prices and increasing volume .The combination can be lethal, and sometimes, there is no second chance return to the support break.
• Measuring the expected length of the decline after the breakout can be helpful, but it is not always necessary target. As the pattern unfolds over time, other aspects of the
technical picture are likely to take precedence.