What is the Head and Shoulders reversal pattern?
Let us start from the right of the below graph, notice the down trend, the stock continues heading down to around $7,694 than spikes up. This forms the first shoulder in this pattern. The stock then hits a resistance level at $9,000 and then turns down.
The stock continues to head down to $7230, bounces and spikes up. This forms the head. Then it stops at the same level of resistance it did earlier ($9000) and heads down. It stops at $7,500 and heads up. This forms the last shoulder and we would expect a trend reversal after that.
Some aggressive traders could buy after the bounce off the last shoulder at $7,500. More conservative traders however would wait until the stock goes above $9000 before buying.
If you would have seen this head and shoulders you would have gotten in at the bottom of the bears market in the early 2000s. Why does it work? A downtrend consists of making lower lows and lower highs. However on this pattern that switches. At first the stock fails to make a lower high after the head. Then the stock fails to make a lower low during the last shoulder. Both indicate that the trend is weakening. When the stock breaks above $9000 in this case you can see it has not only stopped making lower lows and lower highs, but it has made a higher low and is heading towards a higher high. Both of those are signs of an uptrend not a downtrend. Other Patterns Ascending Triangle - A bullish indicator that can take weeks or months to form Flat Base Pattern - A common pattern Cup and Handle Pattern – A short term bullish pattern
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