1. Prior Trend: Importantly, the establishment of a prior trend is required for this to be considered as a reversal pattern. Without the history of a proceeding up trend to turn, a head and shoulders top cannot be confirmed.
2. Left Shoulder: on this uptrend formation, the left shoulder forms a peak and defines the new reply high in the existing trend. Once formed, the potential advance ensues and by it completes the left shoulder pattern (1).
3. Head: the left shoulder low points mark an advance that far exceeds the previous high and creates the head of the pattern. A further decline represents the right hand side of the neck line.
4. Right Shoulder: the third advance creates the right shoulder, this rally is lower than the head and is usually equal to the left shoulder rally, and it is preferred to have a symmetrical pattern but sometimes not the case. The fall of the share price (right shoulder) should breach the neckline.
5. Neckline: the neckline evolves by simply connecting the two reaction lows (1 and 2). The answer low 1 completes the constitution of the left shoulder and the source of the head. The reaction high 2 completes the formation of the head and the development of the right shoulder. Depending on the association of the two reaction lows the neckline can slope up, down or be parallel in appearance. The slope of the neckline will affect the patterns degree of confidence in the stock. A downward slope indicates a more bearish sentiment in the market
6. Volume: with the head and shoulders top pattern unfolding, volume has an important role in the confirmation of the pattern. It is preferable that the volume during the left shoulder pattern is higher than the advance head section. The warning unfolds with the decreased volume. The following warning is when the volume increases on the rapid fall towards the neck; the conclusion is when volume increases even further as the price falls away at the right shoulder.
7. Neckline Break: The head and shoulders bottom pattern is not completed and the uptrend is not reversed until the neckline support is breached. There have to be a convincing expansion of volume for this to be defined.
8. Hold turned Resistance: when the support is broken, it is quite usual for these same levels of endorse to evolve into resistance. On occasion but not always the share price will fall to the support break and this gives traders a second opportunity to close positions.
9. Price target: Once the neckline resistance is broken, to project the possible decline, you would calculate the following. You measure the distance from the neck line to the top of the head. You then subtract the measuring from the neckline to reach the fresh price target in the future. This should entirely be used as a guide to the target price as other factors can come into play.
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