A classic bearish reversal pattern, the head-and-shoulders pattern forms at the top of a trend. It is composed of a left shoulder, a head, a right shoulder, and a neckline. It is similar to a double top, except that it has a peaking formation, which juts up between the right and left shoulders on high volume. The right shoulder should be slightly lower than the left and usually occurs on lighter volume.
The best time to sell short following this pattern is after a bounce upward toward the middle of the right shoulder and then a reverse downward through the neckline. A head-and-shoulders top produces heavy resistance and a change in sentiment. Refrain from trading from the long side until price action clears above the top of the head-and-shoulders pattern. This pattern can be spotted on a weekly, daily, and intraday basis.
The chart in Figure 16-9 shows a head-and-shoulders top formed in EBAY. Remember that charting is part art and part science. Patterns do not always look picture-perfect, and they are open to interpretation. Once you have the basic concept down, you will be able to spot patterns that portray the same messages as the classic formations. This chart of EBAY is a good example of a head-and-shoulders pattern that could be interpreted as having two right shoulders.
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