John Lansing

Technical Analysis 101: Head-and-Shoulders Top

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A head-and-shoulders top is considered a bearish signal. It indicates a possible reversal of the current uptrend to a new downtrend.

The head-and-shoulders top is an extremely popular pattern among traders because it's one of the most reliable of all formations. It also appears to be an easy one to spot.

Novice investors often make the mistake of seeing a head-and-shoulders top everywhere, but seasoned technical analysts will tell you that it is tough to spot the real occurrences.

The classic head-and-shoulders top looks like a human head with shoulders on either side of the head. A perfect example of the pattern has three sharp high points, created by three successive rallies in the price of the financial instrument.

The first point -- the left shoulder -- occurs as the price of the financial instrument in a rising market hits a high and then falls back.

The second point -- the head -- happens when prices rise to an even higher high and then fall back again.

The third point -- the right shoulder -- occurs when prices rise again but don't hit the high of the head.

Prices then fall back again once they have hit the high of the right shoulder. The shoulders are definitely lower than the head and, in a classic formation, are often roughly equal to one another.