Guidelines to trade by Head and Shoulders Bottoms

  • A head-and-shoulders bottom is a three-valley chart pattern that resembles a person’s bust, inverted. The head is below the adjacent shoulders, and it acts as a reversal of the downward price trend.

  • Downward price trend Look for a short-term price trend leading down to the head and shoulders bottom. Three valleys The head and shoulders is a three valley pattern with the middle valley bottoming below the other two. The three valleys and two armpits (peaks between the valleys) should be welldefined minor highs and lows.

  • Neckline, confirmation The neckline is a line drawn across the two armpits. A close above this line confirms the head-and-shoulders as a valid chart pattern. For upsloping necklines, use a close above the right armpit as the confirmation price

  • If the neckline slopes upward from a head-and-shoulders bottom, use a close above the right armpit as confirmation instead of a close above the neckline.

  • Measure rule Compute the formation height by subtracting the lowest low

reached in the head(s) from the neckline, measured vertically. Add
the result to the breakout price where prices pierce the neckline.
The value is the minimum target price.
Trade inner head Trade the inner HSB. That approach will allow you to get in at a
and shoulders good price. See Chapter 24 on head-and-shoulders bottoms for
specific trading hints.
Stop loss Stocks sometimes decline to the lowest of the right shoulders then
turn around. Look for support areas near the shoulders. Place a
stop-loss order 0.15 below the lowest shoulder or head.
Watch for Buy or add to the position during a throwback. Wait for prices to
throwback finish falling before placing the trade as prices sometimes throw
back and continue moving down.