Welcome to Bravechart. Your in-depth article on chart analysis from a Scotsman stationed in the Outback.
As traders, we use technical analysis as a reliable method for speculating on future price direction of both equities (shares) and indexes. Technical Analysis in simple terms is the study of historic price movements in a chart in search of patterns or consistently traded support and resistance levels. Today we are looking at a specific chart pattern that falls under “Reversal Patterns”, the Head and Shoulders.
Appearance: A Head and Shoulders is comprised of:
- Bullish movement to a resistance level creating the first (Left) Shoulder.
- The subsequent fall to a support level, creating what is known as the ‘Neckline’.
- The bullish rise after hitting the Neckline with the share price breaking through the Left Shoulder resistance level and creating a higher resistance level – this is called the Head.
- The fall back to the Neckline, then a run up to roughly the ‘Left Shoulders’ resistance level where it reverses once again (Right Shoulder).
- The final part of the Head and Shoulders to be complete, the break of the Neckline, and a reversal in the long-term trend.
Bearish Reversal Pattern: The Head and Shoulders can be a very reliable bearish reversal pattern. You can see that after the share price has the rally up to create two resistance levels, it eventually falls through the neckline and then confirms the reversal in trend, and the bearish move lower. Often, it can be the beginning of a downtrend and is often more reliable when it occurs after a keen rally. Often it is considered a longer-term reversal pattern rather than a short term one.
Important Note: The Head and Shoulders is not confirmed until the Neckline has been broken.
Example: Sims Metal Management
SGM has been in a long-term uptrend that has been forming for over a year. The share price has been bouncing around and creating new resistance and support levels over the last twelve months. Recently however, the share price created a Head and Shoulders pattern in the last 4 months. As can be seen in the below graph, you can see that the left and right shoulders are at the same levels, with the Neckline roughly at the same points. The pattern was only completed when we saw the share price fall through the support level (Neckline) at roughly $15.16. To work out the fall of the reversal, you can take the movement from the neckline to the head – then roughly the same move should be seen to the downside. We can see with SGM, this has almost played out, but it could continue lower as it is now potentially trading in a short term downtrend.
There are many ways that you could take advantage of these patterns. As a specialist in derivatives, we are able to profit on a stock when it falls as well as when it rises.
If you would like to learn how to pick a stocks direction, then Join us at our live face to face one day “Technical Analysis, Picking the Direction of a Stock” course.
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