For investors, the proper interpretation of stock chart patterns is both an art and a science. It is an art because charts often inherently demonstrate how human beings choose to buy and sell their stocks in a certain time and historical moment. This is  especially the case, when market sentiment is constantly creating an atmosphere of constant conflicting emotions of  both fear and greed. For most investors, chart interpretation is also a science because there is a long well studied history on the matter of how stock charts form and develop. This long history of scientific stock chart interpretation provides a degree of certainty to an analyst as to how investors will most likely behave in their buying and selling. While no study of stock charts is completely full proof,  or free from some random event or defect, there are a number of known and recognized chart patterns that investors commonly utilize for their ongoing approach in placing their trades. One of these chart patterns is commonly called "a head and shoulders pattern."

A "head and shoulders" pattern looks something like the following. Imagine for a moment,  a starting place on the left side of a chart page. The starting point is in the lower left hand corner of a chart. As stock XYZ is bought and sold each day, it begins to rise in value. The rise of XYZ, however, is not straight up. Rather, the rise is steady and slow, so the chart shows a pattern of movement up and to the right. The chart records the closing price each day as time passes, and this rise is ongoing and regular. Suddenly, the stock begins to go into what is called consolidation. This means that there are just about the same number of buyers as sellers each day. So, instead of the chart showing that the stock is continuing to rise upward, it  changes, showing the closing prices of the stock basically moving sideways. Then, all of a sudden, the stock begins undergoing what is call accumulation again. This simply means that the stock again has more buyers than sellers. Now, the chart changes. There is a sudden rise and dramatic movement upward towards a new high. After a few weeks, the stock goes into consolidation again. Now the chart moves sideways. This is what analysts call a top. What follows next is an almost exact copy of what happened on the way up, but this time, the direction is down. The stock undergoes strong selling, and the chart begins to show a drop in price for the stock, down to the support levels established previously on its way up. These support levels are located opposite of the point on the chart where the stock underwent consolidation the first time. Then, XYZ moves sideways for a while again, finally breaking through the support levels previously established, and continuing its journey downward to it's original starting price again. In essence, the stock has made a journey in time and price from its starting place on the left hand side of the chart, to its ending point on the right hand side of the chart. The price is now the same as when it started. The difference, however, is that XYZ took a long journey, and that journey formed what looks like a pattern that seems to the observer to be shaped like a head on top of two shoulders. This is what chartists call a "head and shoulders pattern."

Believe it or not, this pattern is quite common among the charts of stocks in the Stock Market. It occurs all the time in lots of markets, and it you are well trained enough to recognize it when you see it, you can make some big money by taking advantage of this pattern. How? First, let me say that for the purposes of this article, I am assuming that you know how to short a stock. If you don't know how to short, talk to your broker. He or she will give you a basic course. But before you do anything, read as much as you can about shorting stocks. Shorting is not a simple process. It is complicated, and it takes a high level of skill and understanding. But this does not mean that you cannot learn how to short stocks and make big money doing so. All I am suggesting is that you take your time and learn how to short stocks over a period of training and practice. Paper trading is always a good way to learn how to begin a new practice in your investing life. You can choose a few candidates of stocks to short, and then basically pretend that you are selling those stocks short. As time passes, you can check to see exactly how well you did in your shorting. If you did well, then do some more. If you do poorly, then do A LOT MORE.  KEEP PRACTICING YOUR SHORTING UNTIL YOU ARE MAKING MONEY ON PAPER. ONLY THEN TRADE YOUR OWN REAL, HARD EARNED, MONEY. 

Anyway, "head and shoulder patterns" provide a trader with an opportunity to make money both as a buyer and as an investor selling short. If you can recognize that the pattern is forming in a stock, you can also take the proper action. If the stock is topping out at what appears to be a head shaped pattern, after a long trip upward from its bottom, you can initiate a short. If the stock is completing a downward pattern to its original starting  point in price, you can buy the stock for appreciation. Either way, you can make big profits.

By the way, sometimes stocks go through what is basically called a channel. This phenomenon is actually a seriee of "head and shoulders" patterns.  When this occurs, and you happen to stumble upon a stock that is actually doing this, you should consider jumping up and down, cheering, and throwing some kind of party for your family and friends. The reason for this kind of celebration is that this repeating phenomenon of "heads and shoulders" in a series, when it occurs, gives an investor the opportunity to really clean up. These kind of ongoing "head and shoulder" repeating patterns create a kind of price channel of value that a stock has a real hard time escaping.  When a stock moves from the bottom of its head and shoulders to the top and then back down to the bottom again, and it does this over and over again, you, the investor, can buy it for appreciation and sell it short, over and over again for big profits too.

Right now, there are many stocks in a repeating head and shoulders pattern on the NYSE. I am going to give you two stocks to look at and to consider. The first is MON. Pull up the chart on Monsanto, and you will see the classic repeating "head and shoulders" pattern. Right now, the stock is making its way down towards it's channel bottom at 70. Buy the stock when it nears that bottom. Hold the stock to 90 or 92, depending on how brave you are. Then, sell MON short, hoping for another trip down to 70. As always, you should utilize a stop to make sure that you protect yourself. If MON does not go back down, the stop will take you out of the trade.

The second candidate is NOK. Pull up Nokia's chart. Study it carefully, and you will see that this stock is also in a classic price channel. Right now, the stock is approaching its low of 12. When it reaches near that level, buy. As NOK reaches 16, sell the stock and go short, hoping for a nice journey back down to 12. Use a stop to protect yourself and hedge your trade.

The "head and shoulders" pattern is a classic in the field of stock charting. Learn it well, and you can improve your investing skills and make big money in the Stock Market. Just remember, nothing lasts forever. Keep tabs on the news, particularly on your stock. If something radically changes in the earnings or some other aspect of your stock, keep in mind that your candidate may begin to undergo a transition to another pattern of investor buying and selling. Otherwise, good luck and good trading.
 

John K. Brackett, Ph.D.

All Rights Reserved

#ff0000