Head and shoulders chart pattern is one the most commonly occurring reliable chart pattern. It is a reversal chart pattern that indicates that prices are going to move against the current trend. There are two types of head and shoulder pattern , head and shoulder top and inverted head and shoulder.
1. Head and Shoulder Tops
A head and shoulder tops patter indicates the end of uptrend. The peak price forms the head surrounded by two lower peaks called as shoulders. A neckline connects the lows of declines from the left shoulder and the head. The neckline can be flat, rising, or faling. The falling necklind is specially bearish, it shows that the bears are becoming strong.
When the price fail to rally above the head, the confirm that a head and shoulders top is forming. The right shoulder may be higher or lower that the left and may be shorter or longer. The decline from the right shoulder breaks the trendline, which conforms the end of uptrend. After the break of neckline, prices can sometime pull back to it on low volume. This proves the excellent shorting opportunity, with a logical stop just above the neckline.
Volume is generally low on the head than on the left shoulder. It is even lower on the right shoulder. Volume increases when prices breaks the trendline. When the price pulls back volume is low.
Head and shoulder tops provides an approximate downward target. Downside target can be calculated by measuring the distance from the top of the head to the neckline and projecting this down from the neckline.
The below chart of Nifty shows the working of head and shoulder tops chart pattern
2. Inverted head and shoulder pattern
This pattern is also known as head and shoulders bottom, its a mirror image of a head and shoulders top. This pattern indicates that downtread is getting weak and the tread could reverse. When a decline from the neckline fails to reach the level of the head, it creates a right shoulder. When prices rally from the right shoulder above the neckline with the increase of volume, the inverted head and shoulder completes and a new uptrend begins.
Sometimes there can be pullback to the neckline on low volume, this offers good buying opportunity. The upward target can be obtained by measuring the distance from the bottom of the head to the necline and projecting it upward from the point where the neckline broke.
The below charts demonstrates inverse head and shoulder chart pattern.