Head and shoulders top

My observation of a head and shoulders top is confirmed whenever you evaluate the following: A head and shoulders top design is an advance to a newly high followed by helplessness to intermediate hold, a succeeding rally to a higher high, a failure to hold it and a decline to the support level. This rally is retested to an unassuming third rally followed by a sharp fall through the support levels.

Why does this occur?

Head and shoulder patterns are reversal patterns that are amongst the most significant in terms of reliability and frequent. The head and shoulders pattern consists of three rallies and then a breakdown to a new low. The pattern is moderately frequently quoted as the middle rally is described as the head (the highest point of the rally). The first and third rally is generally of equal height representing the shoulders.

This pattern generally evolves from an extended rally to new highs. The opportunistic traders are seemingly confident based on the market information being rather positive. You could have a re-rating of a buy from research houses to confirm the market sentiment. This could push the stock price higher, but only days after these profit takers decide to sell it off and take profits. This causes a pullback or a reaction low. Traders appear to accept the profit taking and show no concern for the weakness, unfortunately trouble waits.

On the first decline those traders who had been more assertive buying at a lower price begin to sell off their positions in to the positive sentiment. They have reached their profit targets and are keen to move on. The stock price falls and hits a reaction low. Long term holders of the stock hold the rate at the reaction low and since a few days the stock regroups on further positive news and the share rate reaches a new second high, much higher than the first new high. Even with the positive sentiment and positive market conditions the stock cannot hold this level as the volume of buyers has dried up. This creates the head or the second high. The sell off begins smartly as earlier buys attempt to look after their gains. The institutions also decide to protect their profits and possibly there are traders pushing the stock lower. The stock declines back to the reaction low, extra positive speculation hits the market and forces up the price, some traders cannot resist a bargain.

Regrettably, the final third rally of the pattern is less convincing than the previous two earlier advances. The stock price does mover higher although the volume is weak and stock dispersion is lucid. Following a number of sessions the declines return and the stock moves back to the reaction lows. This is often called the neck line (within keeping of the image of the head and shoulders pattern). Unperturbed the sellers ignore the market opinion and the sell off is widespread and solid. The heavy volume causes the stock to collapse and over the coming weeks the portion trades at its long term support levels.

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