In the previous examples, you have seen the double bottom pattern. The first example in this module will show you the head and shoulders pattern. We will then discuss the other patterns that exist.
Head and Shoulders Pattern
What does a Head and Shoulder Pattern look like? The importance of the head and shoulders pattern should not be under-estimated—one of the most reliable patterns in technical analysis, yet one of the most misunderstood.
Here we discuss the famous head and shoulders price pattern. Understood to be one of the most predictive patterns, the Head and Shoulders pattern has unique characteristics.
However, you do need to know what you are looking for.
A Head & Shoulders Pattern has the following traits.
- Two shoulders.
- A high point, the head in between the shoulders.
- The volume should confirm the pattern.
So what lessons can we learn from the chart?
- This is the left shoulder.
- This is the head.
- This is the right shoulder.
- This is the neckline, using a trend-line connect the low from both sides of the head through the outer price limes.
- The left shoulder was formed on increasing volume. This is to be expected.
- In the forming of the head, we see a significant decrease in volume.
- In the right shoulder, we also see decreasing volume.
- The price failed to exceed the previous peek.
All of the above conditions of the Head & Shoulders pattern here are consistent with textbook descriptions. See the classic book Technical Analysis of the Financial Markets by John J Murphy as a reference.
The Head and Shoulders pattern is said to be confirmed on a break of the neckline; this is about to occur/has occurred in the final price bar in July.
There are other patterns to understand before we move to the next chapter.
Here we have a Megaphone Top. This is a rare pattern that usually occurs at major tops. You can see that the swings get larger at each bounce, suggesting uncertainty and volatility until finally, the price breaks out downward on increased volume.
Wedges have a very different character to triangles in the fact that they point in the exact opposite direction to the breakout. Both of the edges of the wedge point in the same direction, either upward or downwards. In the image below, we can see that the falling wedges signify an upward breakout.
The rising wedge signals a downward breakout.