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Stock Chart Reversal Patterns – Head and Shoulders

The previous post had discussed about a few stock chart continuation patterns. This week we’ll look at another type of stock chart pattern – the reversal pattern. Please note that the screen shots may not perfectly reflect the definition of that pattern, which a trader performing technical analysis would look for and accept and only meant to provide some visual idea instead of mere text (click on images for enlarged views).

Reversal Type Patterns

As would be evident from the name, a trend needs to have been established prior to the emergence of a reversal pattern. A breakout from a trend line indicates the trend reversal with a larger pattern signaling a bigger move in price. There are several types involved and four of them are listed below.

Head and Shoulders Top

HeadandShouldersTop

A head and shoulders top is a bearish reversal stock chart pattern. Following an uptrend, the price movement tends to form a pattern with three highs resembling a left shoulder, head, and right shoulder, and a neckline buttressing the lows. The volumes during the pattern are higher at the left shoulder than at the head indicating that the price is increasing without any major interest in the stock and suggesting that a reversal is on the cards. A breakout through the neckline (dips in price) with increasing volume confirms the reversal pattern.

Head and Shoulders Bottom

HeadandShoulderBottom

A head and shoulders bottom is a bullish reversal pattern. Following a downtrend, the price movement tends to form a pattern with the three lows resembling an inverted head and shoulders top pattern. The volumes during such a bottom pattern are higher at the left shoulder than at the head indicating that the price is falling without significant market participation. A breakout through the neckline (price peaks) confirms the reversal pattern.

Double Top

DoubleTop

A double top is a bearish reversal pattern. During an uptrend, the price chart shows a couple of peaks, which may or may not be at the same price, with a few lows between them. A double top pattern is confirmed when a reversal occurs with the prices unable to attain a new peak and fall below the lows (between the peaks), usually with increasing volume.

Double Bottom

DoubleBottom

A double bottom is a bullish reversal pattern. During a downtrend, the price chart shows a couple of troughs, which may or may not be at the same price, with a few highs between them. A double bottom pattern is confirmed when a reversal occurs with the prices unable to pierce the existing trough line and increase above the highs (between the lows), usually with expanding volume.

About the Author: Clark works in Saskatchewan and has been working to build his (DIY) investment portfolio, structured for an early retirement. He loves reading (and using the lessons learned) about personal finance, technology and minimalism. You can read his other articles here.

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 4 comments… add one }
  • DanP May 11, 2011, 5:39 pm

    For the “double top” and “double bottom”, are there any signs to look for while they are happening to see which way it will break out? For instance, you could definitly see a double bottom occur, only for the stock to fall apart days later.

    What i dont understand about technical analysis is how do you tell if a “double bottom” is happening in the moment? In your “double bottom” example, it seems like you could only tell if twas a double bottom if you looked at the chart in april, and said that the double bottom happened in nov/dec. And by the time April rolls around, i’ve already missed a huge chunk of the upside and it might be too risky to jump in now. I’ve never understood that part of technical analysis.

  • Clark May 11, 2011, 11:28 pm

    @DanP: Excellent points/questions! I do not know the finer points of technical analysis to give you an answer. Also, I am not sure how one could know if my “double bottom” example would not become a triple bottom pattern. However, it wouldn’t matter much since both are reversal patterns. I wish someone who knows the ins and outs would chime in…..

  • MB May 11, 2011, 11:39 pm

    @DanP:

    You will not know which way the price will break before hand. That’s not how the traders use the chart.

    For instance: In a “double bottom” situation, many will wait till the price breaks above the high of W (middle peak) with volume. Then the stop will be set below the bottoms of W. If playing the continuation play, then the trader will wait till the price breaks below W (with volume) to short and will set the stop above the middle peak (of W). The key is to identify the current market breadth, so you can make informed choices on the market direction. There’s more to it than just looking at W or M shapes – eg. time, volume, strength of support, trendline breaks, etc.

    Also a quick comment on “double bottoms”. They come in several variations. Typically, right side low (of the W) will have a less volume than left. In addition, when the price breaks out (price trading above the middle peak of W), there will be increasing volume as well.

    Here’s more infomation if you are interested:
    http://www.trending123.com/patterns/double_bottom.html

    MB

  • FT FrugalTrader May 12, 2011, 10:31 am

    @DanP, what you are looking for is a breakout out of the formation. So for example, with a double bottom, you’ll looking for a close above the middle “bump” which would indicate that the price “may” go higher. If the price closes below the double bottom points, then it’s likely that the price will go lower.

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