Option Investor
Glossary

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Head and Shoulders Pattern

A head and shoulders pattern is a reversal pattern that, as you may have guessed, resembles a head with two shoulders on either side. There are many factors demonstrated by a head and shoulders pattern, such as a lack of momentum, support/resistance breakthroughs, and breaks in trend. In a rising market, prices will reach higher highs and make higher lows as the upward trend continues. This forms the left shoulder of the pattern. Prices rise to create the top of the shoulder and fall in a normal pattern of retracement or correction down to a level of support. Following the formation of the left shoulder, prices will continue to rise until a final push in the rally will begin to form the head. This is where you will begin to see potential weaknesses emerge, such as a lack of volume backing the rally or the force of the momentum beginning to falter. As the prices begin to pull back, they fail to set a higher low and fall to a previously established low. This is where the neckline is formed. Then, the market will attempt a rally but will be unable to trade up to the previous high and we see another pullback, which forms the right shoulder. The reversal pattern is complete when there is a break through the neckline.