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When you think of head and shoulders the first thing that probably comes to mind is the shampoo and Odell Beckham with his soft curly hair. While shampoo can give you a great return on your investment in the form of 10/10 looking hair, there is another use for the name head and shoulders that directly corresponds to trading. In this article, I’m going to be discussing the head and shoulders chart pattern and showing you how it can make you 10% on your investments.

 

What does the pattern look like?

 

 

The picture above is a basic head and shoulders pattern. Its very easy to remember and spot in technical charts because it is just like the human body! One head that is above two shoulders. One shoulder to the right and one to the left. The pattern is an indication that a rising stock may be reversing its course. We draw a “neckline” below the 2 troughs in the pattern to show where there is some support in the stock price. When the price of the stock falls below the neckline on a head and shoulders pattern it is said to be extremely bearish and we can expect a downward movement in the stock price.

 

Inverse Head and Shoulders

 

There is also an inverse head and shoulders pattern that is just the opposite. The neckline in this pattern becomes the resistance level for the stock price and if there is a break in this resistance level after the second shoulder has emerged then we can see a positive price breakout. For this reason, the inverse head and shoulders pattern is said to indicate a bullish breakout in price.

Target Profit

 

After we see the price breakout on one of these patterns, how far can we expect it to go? There is a specific formula to calculate the anticipated move from the head and shoulder pattern. This formula and percentage to target price is based off of the research done by Thomas Bulkowski. Thomas was able to retire off of his investments by age 36 and is known as an expert in technical analysis. The figures and formulas are based off of thousands of successful trades.

 

 

  1. Compute the height from the head low (A) to the neckline directly above (B) 

 

In this case 38(B) minus 32(A) to get 6

 

  1. Multiply it by the “percentage for price target” which is 74%(% comes from Bulkowski)

 

6*74%=4.44

 

  1. Add it to the breakout price (C).

 

4.44+34(C)=38.44

 

So as you can see our target exit price with GNRC would be $38.44. If you entered into this trade at the right shoulder (C) then you would have made close to a 10% return on your investment.

 

 

The regular head and shoulder pattern would be just the opposite with a new percentage for price target.

 

  1. Compute the height from the head low (A) to the neckline directly above (B) 

 

In this case 70(A) minus 59.30 (B) to get 10.7

 

  1. Multiply it by the “percentage for price target” which is 55% (% comes from Bulkowski)

 

10.7*55%=5.89

 

  1. Subtract it from the breakout price (C).

 

65(C)-5.89=59.11

 

As you can see, our profit exit would be $59.11 if you had shorted GLTR. If you shorted GLTR at the right shoulder (65) and exited at 59.11 then you would have made roughly 10% on your trade.

 

This pattern is similar to the wedge pattern I spoke of in a previous article because you want to see good volume on the price breakout to confirm the success of the pattern. Remember that while these patterns enhance your probability of success, they do not GUARANTEE results. Always protect yourself against downside risk with an exit strategy incase things don’t go your way.

 

Homework:  Screen for some head and shoulders patterns using finviz.com and see if there are an potential price breakouts coming in the future.

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