From this figure head-and-shoulders is derived. This
expression comes from the form of the figure, showing three consecutive
tops, the first one and the third one being of the same height while the
second one is higher (cf. graph).
The main element of this figure is what is called
“neckline”, corresponding to a horizontal line joining the low points
of the second top. Indeed, this figures often characterizes a trend
reversal.
Up to the second top (head), the stock is standing on a
bullish trend, which is broken down by drawing the second shoulder. It then
reaches a downward trend, which is confirmed by the crossing down of the
neckline after the second shoulder.
Still, one can often have a phenomenon called “pull
back”, corresponding to a return of the price right under the
neckline. This return often corresponds to a technical rebound, as it
often occurs in low volumes.
More precisely, the appearance of the top (head) can be
forecasted whenever volumes significantly fall, standing at a lower level
compared to volumes reached during the first shoulder.
In terms of target, it is calculated just as the
double top, by moving the figure height (head height relatively to the
neckline) at the end of the figure (crossing down of the neckline). Of
course, a symmetric figure can be drawn on the downside. It is then called
reverse head-and-shoulders.
