The Formation of Head & Shoulders Top Pattern
Head and Shoulders Top Pattern contains three consecutive, sharp peaks / tops, whereby the middle peak is the highest (Head) and the other two peaks (left & right peaks) are lower & roughly equal in size (Left & Right Shoulders).
This pattern forms when the price is in an existing uptrend. The price increases and hits a high then declines (forming the Left Shoulder). Afterwards, the price increases to an even higher high and then declines again (forming the Head). The Right Shoulder is formed when the price rises again but it does not hit the high of the Head. Instead, the price falls back after it has reached about the same price level as the Left Shoulder.
Although the Left & Right Shoulders do not necessarily need to be exactly the same, but it should appear roughly equal to one another.
The important part of this pattern is the Neckline. The Neckline is formed by drawing a line that connects two low points: (1) the low point in between the Left Shoulder & Head, and (2) the low point in between the Head & Right Shoulder.
This Neckline can be horizontal, sloping upwards or downwards.
The pattern is only completed and confirmed when the price decreases and closes below the Neckline, which serves as the key support level in this pattern.
Although Head & Shoulders Top is viewed as a common pattern and quite easy to identify, it’s actually not the case. Therefore, one should pay close attention & take proper steps to analyze the characteristics of Head & Shoulders Top in order to minimize / avoid making mistakes in spotting the pattern.
The characteristics of the pattern will be discussed in more detail in the next post.
Continue to Part 2: Important Characteristics of Head & Shoulders Top pattern.
To find out more about other Chart Patterns, please refer to:
Learning Charts Patterns
* 10 Important Trading Lessons
* Learning Candlestick Charts
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Option Greek
* Understanding Implied Volatility (IV)
* Understanding Option’s Time Value
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