John Lansing

Technical Analysis 101: Head-and-Shoulders Bottom

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A head-and-shoulders bottom is considered a bullish signal. It indicates a possible reversal of the current downtrend into a new uptrend, and it's a popular pattern with investors. This pattern marks a reversal of a downward trend in a security's price.

Trading volume is absolutely crucial to a head-and-shoulders bottom. A trader will be looking for increasing volumes at the point of breakout. This increased volume definitively marks the end of the pattern and the reversal of a downward trend in the price of a stock.

A perfect example of the head-and-shoulders bottom has three sharp low points created by three successive reactions in the price of the financial instrument. It is essential that this pattern forms following a major downtrend in the financial instrument's price.

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

The second point -- the head -- happens 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 -- occurs when prices fall again but don't hit the low of the head. Prices then rise again once they have hit the low of the right shoulder.

The lows of the shoulders are definitely higher than that of the head and, in a classic formation, are often roughly equal to one another.