Chart Patterns to avoid:  Head and Shoulders Top

The Head and Shoulders Top is another chart that may indicate a stock has made a top.  Usually a Head and Shoulders pattern will have a Head and two Shoulders with a Neckline connecting the bottom of the two Shoulders.  The stock price should find support at the Neckline however if it breaks below that support then the stock price could spiral downward.   I certainly don't profess to be an expert in Head and Shoulder formations but here are a few examples.

Here is a chart of EBAY which shows a top (Head) being made in late April.  Normally a Head and Shoulders pattern has two Shoulders however there appears to be three Shoulders in this case (points A, B and C).  Determining exactly where to draw the Neckline can be subjective but for this case I will define it from points D to E.  In theory the stock should find support at its Neckline if the price drops after forming the second Shoulder (point B).  In this case the price dropped back to the Neckline and then rebounded to form a third Shoulder (point C).  EBAY then dropped again and fell below the Neckline and continued in a downtrend until early August.

The next example shows a chart of LVCI.  The Head develops in mid-July as the stock makes a top.  The two Shoulders are defined at points A and B while the Neckline is defined by the line from points C to D.  Once again as the stock broke through its support area at the Neckline it continued to drop for several more weeks.

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