UK Accounting Glossary
A head and shoulders pattern is a technical analysis charting pattern that signals the reversal of an uptrend — it’s a bearish reversal signal. Three peaks, with the middle peak the highest, and two valleys that touch a support level characterize a head and shoulders pattern. The support level of the head and shoulders pattern is also referred to as the neckline. Initially, buying pressure is strong when the peak of the left shoulder in the head and shoulders pattern forms. A relatively short sell-off completes the left shoulder of the head and shoulders pattern. A new advance that reaches a peak higher than the left shoulder, followed by another sell-off to support (i.e. the neckline) forms the head of the head and shoulders pattern. Sometimes the formation of the head in the head and shoulders pattern will occur on lower trading volume than was in process for the left shoulder which is another indication that support for the security is weakening. The right shoulder of the head and shoulders pattern reaches a peak lower than the head and is often in line with the left shoulder. Traders consider the reversal signalled by the head and shoulders pattern confirmed when the sell-off from the peak of the right shoulder breaks below the neckline (preferably on increasing volume). The target price for the head and shoulders pattern is determined by calculating the price differential between the neckline and the peak of the head and then subtracting this differential from the neckline.
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This glossary post was last updated: 9th February 2020.