Head and shoulder top and bottom formations are usually confirmed by measures of market momentum, such as the rate of change. Momentum generally declines as the formation develops along. Positive divergences (at market bottoms) and nega-tive divergences (at market tops) provide additional evidence that significant changes in market climate might be developing.
Bearish head and shoulder formations often take place in Stage 3 (market topping), and bullish formations typically take place during Stage 1 (market base building). The t i e required to complete of such formations provides the opportunity for investors to carefully reduce or to accumulate positions.
Confirmation by Measures of Market Momentum
Futures
Comments Off
Head and shoulder bottom formations can appear as a formation that develops inversely to the head and shoulder top formation, in which case the pattern becomes a buying rather than a selling formation.
The same basic descriptive patterns occur, though reversed to the head and shoulder top.
1. A market decline takes place. At its conclusion, a high-volume spike often occurs. This ultimately becomes the lee shoulder in the formation. Such a decline took place during June and July 2002.
2. A rally takes place, which is then followed by another leg down on lower volume than the first decline. This leg down generally carries to below the leg down that precedes it. When the decline ends, a rally carries to the area of the previous advance, with trading volume still decreasing.
3. The completion of this second market recovery provides the opportunity to define the neckliine of the formation. A final decline from the new neckline on still-diminishing volume leads to the final and right shoulder of the formation. The formation is complete when the neckline is penetrated from below.
4. Minimum price objectives for the inverse head and shoulder formation, a bullish pattern, are secured by measuring the distance from the neckline to the head and projecting this measurement upward at the area where the neckline is penetrated. A very significant longer-term inverse head and shoulder formation developed in the Dow Industrials between the summer of 2002 and the spring of 2003. The price objectives of that formation were achieved during December of that year.
Head and shoulder bottom formations are among the more accurate of chart patterns, but there are occasional failures nonetheless. Sell stops should be placed below the lowest level of the right shoulder in the formation.
