Chart Patterns : Head and Shoulders

This is one of the most popular and reliable chart patterns in technical analysis. Head and shoulders is a reversal chart pattern that when formed, signals that the security is likely to move against the previous trend. As you can see in the above figure, there are two versions of the head and shoulders chart pattern. Head and shoulders top (shown on the left) is a chart pattern that is formed at the high of an upward movement and signals that the upward trend is about to end. Head and shoulders bottom, also known as inverse head and shoulders (shown on the right) is the lesser known of the two, but is used to signal a reversal in a downtrend.

Head and Shoulders Top

The Head and Shoulders Top is an extremely popular pattern among investors because it's one of the most reliable of all formations. The classic Head and Shoulders Top looks like a human head with shoulders on either side of the head. A perfect example of the pattern has three sharp high points, created by three successive rallies in the price of the financial instrument.

The first point - the left shoulder - occurs as the price of the financial instrument in a rising market hits a high and then falls back. The second point - the head - happens when prices rise to an even higher high and then fall back again. The third point - the right shoulder - occurs when prices rise again but don't hit the high of the head. Prices then fall back again once they have hit the high of the right shoulder. The shoulders are definitely lower than the head and, in a classic formation, are often roughly equal to one another.

A key element of the pattern is the neckline. The neckline is formed by drawing a line connecting two low price points of the formation. The first low point occurs at the end of the left shoulder and the beginning of the uptrend to the head. The second marks the end of the head and the beginning of the upturn to the right shoulder. The neckline can be horizontal or it can slope up or down. The pattern is complete when the support provided by the neckline is "broken." This occurs when the price of the financial instrument, falling from the high point of the right shoulder, moves below the neckline. Technical analysts will often say that the pattern is not confirmed until the price closes below the neckline - it is not enough for it to trade below the neckline.

Head and Shoulders Bottom

The Head and Shoulders bottom is a popular pattern with investors. This pattern marks a reversal of a downward trend in a financial instrument's price.A perfect example of the Head and Shoulders Bottom has three sharp low points created by three successive reactions in the price of the financial instrument. It is essential that this pattern form following a major downtrend in the financial instrument's price. Volume is absolutely crucial to a Head and Shoulders Bottom. An investor will be looking for increasing volumes at the point of breakout. This increased volume definitively marks the end of the pattern and the reversal of a downward trend in the price of a stock.

The first point - the left shoulder - occurs as the price of the financial instrument in a falling market hits a new low and then rises in a minor recovery. The second point - the head happens when prices fall from the high of the left shoulder to an even lower level and then rise again. The third point - the right shoulder - occurs when prices fall again but don't hit the low of the head. Prices then rise again once they have hit the low of the right shoulder. The lows of the shoulders are definitely higher than that of the head and, in a classic formation, are often roughly equal to one another.

The neckline is a key element of this pattern. The neckline is formed by drawing a line connecting the two high price points of the formation. The first high point occurs at the end of the left shoulder and beginning of the downtrend to the head. The second marks the end of the head and the beginning of the downturn to the right shoulder. The neckline usually points down in a Head and Shoulders Bottom, but on rare occasions can slope up.
The pattern is complete when the resistance marked by the neckline is "broken". This occurs when the price of the stock, rising from the low point of the right shoulder moves up through the neckline. Many technical analysts only consider the neckline "broken" if the stock closes above the neckline.

 

Looking at the Chart Above of Fortis Healthcare Ltd.(NSE) for period of  June to December, we see a formation of Head & Shoulders Pattern. The neckline(158) gets started around start of September and the first shoulder gets formed at 170 in mid of September. Then the stock again touches the neckline(158) at the end of September. In October it forms the Head at 177 and again touches the neckline(158) at the end of October. In November it finally forms the second shoulder at 171 and by mid November breaks the neckline(158). The Pattern was giving the target of 140-143(approx 15-18 points down from 158) and it exactly did the same by end of November, touching 142.20 as Intraday Low.