John Lansing

Find Bottoms the 'Trendy' Way

by John Lansing   09/18/08

Multiple Head-and-Shoulders-Patterns

Many valid head-and-shoulders patterns are not as well-defined as the classical "head" with a "shoulder" on each side. It is not unusual to see more than two shoulders and more than one head. A common version of a multiple head-and-shoulders pattern includes two left shoulders of generally equal size, one head, and then two right shoulders that mirror the size and shape of the left shoulders.

Flat Shoulders

The classic head-and-shoulders 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 I pay attention to in the head-and-shoulders bottom?

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 do not necessarily dismiss the pattern's validity.

Volume

It is 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.

Duration of Pattern

It is 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.

The Need for a Downtrend

This is a reversal pattern that marks the transition from a downtrend to an uptrend.

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.