What is a head and shoulders top pattern?

The head and shoulders top pattern is a pattern that will often form at the top of a trend. It signals that the trend will probably be coming to an end. It consists of 2 shoulders, (stock highs) and 1 head in the middle that is higher than the shoulders.

In this example the stock headed up to $62.5 and came down making the shoulder. It headed back up to $67.5 making the head and made a second shoulder at $62. When the stock broke $56 that gave us a signal that it is probably heading lower.

volume The volume should be high and increasing when the first shoulder forms. When the other two shoulders formed it should have lower volume. The breakout to the downside should have high volume.

Target The target of a head and shoulders top pattern is found by subtracting the top of the head to the bottom. In this case the top would be $67.5 and the bottom is $56, so we would have a $11.5 move. $56-$11.5 gives us a target of $44.5. This stock hit the target and went past it a little.

trading the pattern A professional trader would sell the stock on the breakout and buy it back when it hits $44.5. They would also place a stop above $56 in case the stock goes against you.