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Head and shoulders bottom

Head and shoulders patternThis is sometimes referred to as an Inverse Head and Shoulders. A perfect example of the head and shoulders bottom has three sharp low points created by three consecutive reactions in the price. It's crucial that this pattern form following a major downtrend in the stock's price.The Head and shoulders bottom is a pattern that shares many common characteristics with its comparable partner, but relies more heavily on volume patterns for confirmation.

The first point - the left "shoulder" - occurs as the price of the stock in a falling market hits a new low and then rises in a minor recovery.

The second point - the "head" - occurs when prices fall from the high of the left shoulder to an even lower level and then rise again.

The third point - the right "shoulder" - happens when prices fall again but do not touch the low of the head. Prices rise again after they have hit the low of the right shoulder. The lows of the shoulders are decidedly higher than that of the head and, in a classic formation, are often more-or-less equal to one another.



The classic head and shoulders bottom pattern is made up of three sharply pointed components - the head and two shoulders - but this isn't always the case. Sometimes, the shoulders may not have sharp low points and will instead be quite rounded. This does not affect the pattern's validity.

What details should you pay attention to in the head and shoulders bottom? Here are seven:
  1. Symmetry

    - In a classic head and shoulders bottom, the left and right shoulders hit their relative low points at about the same price and level. Additionally, the shoulders are typically about the same distance from the head. Experts prefer to see symmetry, but variations don't necessarily dismiss the pattern's validity.
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  1. Volume

    : It's imperative to watch the volume sequence as the pattern develops. Volume will usually be highest on the left shoulder and lowest on the right. Traders who look to ensure that volume increases in the direction of the trend should make sure that a "burst" in volume occurs at the time the neckline is broken.
    1. Volume levels during the first half of the pattern are less important than in the second half. Volume on the decline of the left shoulder is usually pretty heavy and selling pressure quite intense. The intensity of selling can even continue during the decline that forms the low of the head. After this low, subsequent volume patterns should be watched carefully to look for expansion during the advances.
    2. The advance from the low of the head should show an increase in volume and/or better indicator readings, e.g., CMF > 0 or rise in OBV. After the reaction high forms the second neckline point, the right shoulder's decline should be accompanied with light volume. It is normal to experience profit-taking after an advance. Volume analysis helps distinguish between normal profit-taking and heavy selling pressure. With light volume on the pullback, indicators like CMF and OBV should remain strong. The most important moment for volume occurs on the advance from the low of the right shoulder. For a breakout to be considered valid, there needs to be an expansion of volume on the advance and during the breakout.
  1. Duration of pattern

    : It's not unusual for a head and shoulders bottom to take several months to fully develop. Stocks' volume is generally less after a period of declining prices than after a bull market. Because of this lower volume, bottoms take longer to form and tend to be smaller than tops.
  2. The need for a downtrend

    : This is a reversal pattern that marks the transition from a downtrend to an uptrend.
  3. Slope of the neckline

    : In a well-formed pattern, the slope won't be too steep, but be sure not to automatically discount a formation that has a steep neckline. Some experts believe an upward-sloping neckline is more bullish than a downward-sloping one. Others say, however, that slope has very little to do with the degree of the stock's bullishness.
  4. Resistance turned support

    : Once resistance is broken, it is common for this same resistance level to turn into support. Often, the price will return to the resistance break, and offer a second chance to buy.
  5. Price target

    : After breaking neckline resistance, the projected advance is found by measuring the distance from the neckline to the bottom of the head. This distance is then added to the neckline to reach a price target. Any price target should serve as a rough guide, and other factors should be considered, as well. These factors might include previous resistance levels, Fibonacci retracements or long-term moving averages.

Criteria that supports the head and shoulders bottom

  1. Support and resistance

    - Aim to find a region of support or resistance around the target price, which is a strong indicator that the price will move to that point.
  2. Location of moving average

    - The head and shoulders bottom should be below the stock's moving average. Compare the location of the pattern to a moving average of similar length. For short duration patterns, use the 50-day moving average. For longer patterns, use a 200-day moving average.
  3. Moving average trend

    - The moving average should change direction within the duration of the pattern and should head in the direction the pattern indicates. For short-duration patterns, use the 50-day moving average. For longer patterns, use the 200-day moving average.
  4. Volume

    - Volume will usually be highest on the left shoulder and lowest on the right shoulder. A strong spike in volume spike on the day of the pattern confirmation is a strong indicator that supports the potential for this pattern. The volume spike should be notably above the volume average for the pattern's duration.

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