The head and shoulders is a common technical analysis pattern that usually appears in an upward trend, indicating that prices may reverse and fall.
Simply put, from a technical pattern perspective, the head and shoulders chart pattern looks like a human head and two shoulders.
The appearance of the head and shoulder pattern indicates that market sentiment may shift from buyers to sellers, and prices may fall.
So, what kind of technical chart pattern can we call the head and shoulders?
In general, this technical pattern has three obvious characteristics:
1. Three peaks: There will be three peaks on the chart, with the middle peak higher and the peaks on both sides relatively lower. The middle peak is called the head, and the lower peaks on both sides are called the shoulders.
2. Neckline: The horizontal line connecting the bottom of the shoulders is called the neckline, which is an important support line. When the price breaks through the neckline, it may mean that the trend will change.
3. Volume: The head and shoulders pattern is usually accompanied by changes in volume. When the head is formed, the volume is usually high, while when the shoulders are formed, the volume is relatively low.
Observing the head and shoulders pattern is important for predicting price reversals.
Here are two examples to help you better understand this pattern:
1. In 2016, Coca-Cola (KO) formed a head and shoulder pattern, indicating that bearish forces in the market were strengthening. Subsequently, Coca-Cola's stock price fell from $47 to around $36, down nearly 23%.
2. In 2012, McDonald's (MCD) formed a head and shoulders pattern, indicating that the market was gradually turning from a bull market to a bear market. Subsequently, McDonald's stock price fell all the way.
After understanding the above cases, you should also note the following points:
1. Confirm the validity of the pattern:
The appearance of the head and shoulders pattern alone is not enough to confirm a price reversal. You should also wait for the price to break through the neckline to confirm the validity of the pattern. Note that breaking through the neckline may indicate the start of a downward trend.
2. Combine other technical indicators and fundamentals:
Relying solely on the head and shoulders pattern to make investment decisions may not be reliable enough. You should analyze using other technical indicators such as trend lines, support and resistance levels, and comprehensively consider the market environment and fundamentals such as company performance, industry trends, and market sentiment.
3. Pay attention to the time span of the pattern:
The head and shoulders pattern may take some time to form, so investors should pay attention to the time span and cycle of the pattern. Patterns with longer time spans may be more valid.