What is a ‘head and shoulders’ pattern?

'Head and shoulders' is a useful charting concept that spread betters can use in short-term trading. John C Burford explains how.

I have been asked to expand a little on the chart formation known as the 'Head and Shoulders' (H&S). Most traders will have heard of this pattern, but they may not be aware that the concept can be employed in a modified form in short-term trading. So today I'd like to show you how I use it in my trading.

No self-respecting chartist of my era would dream of not searching for H&S patterns at the suspected end of a major bull or bear trend. Below is an example of what a good one looks like and it's a real corker!

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

The chart shows the daily Dow in 2008-2009. It shows the huge bear market starting at the all-time high at over 14,000 to the 6,500 low made in March 2009. From the rally high in early November, the market then plunged to make the new low but on a huge positive divergence with momentum. Remember, this is often a signal to look out for a change of trend up ahead.


(Click on the image for a larger version)

Advertisement - Article continues below

From the low, the market rallied to make an interim high in mid-June. It then dipped again, then resumed the new uptrend.

I have drawn a line joining the interim highs. This line is called the neckline, as the formation beneath it resembles a shoulder on the left (LS), a head (the actual low), and a right shoulder (RS). When a bear market is ending, the head is always below both shoulders. When a bull market is ending, it's the other way around. A standard trade would be to buy when the neckline is penetrated after forming the RS.

How far should the rally take the market?

OK, so how far can we expect the rally to carry? Again, standard H&S theory states that at a minimum, the market will rally to a place equal in distance (in price) from the neckline extension as the head is away from the neckline. I have marked these distances with yellow arrows. Does it make it?


(Click on the image for a larger version)

Yes, indeed, the target was hit exactly in January 2010 for a nice 900 point gain. Also, note that the upper target line for my H&S measure also acts as one of my tramlines there is a real structure to the markets.

Now let's bring this up to date (to mid-February 2011). Here's where it gets really interesting. If I draw another tramline equidistant from the last one, this is what I find:


(Click on the image for a larger version)

Advertisement - Article continues below

In the past few days, the Dow has carried right up to this new line at the 12,300 area. Isn't that pretty? The really fascinating thing is that I could have figured out this precise target line way back in the summer of 2009 almost two years ago from a simple measurement derived from the H&S pattern. That's valuable information.


Claim your FREE report: The 6-step game-plan for
spread betting profits

Now this example shows the classic chartist picture of the H&S. But I also use these ideas on short-term charts where they can occur not necessarily at the end of big moves. It's my own little variation on the H&S theme.

Using the head and shoulders pattern in short-term trading

Here is a chart of the S&P 500 (at the end of January 2011), which is in a bull market:


(Click on the image for a larger version)

The market is in a normal corrective period and has made a typical three Elliott wave (A-B-C) dip to the 1,265 low (marked head and wave C). The market rallied, then dipped to the RS, where I could then draw a neckline between the two interim highs. Buy orders can then be entered as the market moved up through the neckline.

Advertisement - Article continues below

Now that there's a confirmed H&S pattern, is it possible to figure out some price targets by putting more tramlines in place? Well, just look at how trading developed from there:


(Click on the image for a larger version)

Since the market was already in a bull market, we shouldn't be surprised to see it just take off and look at how it has hit all the targets. These targets are derived in exactly the same way as in the Dow example above. Again a very pretty picture.

When I spot a potential H&S pattern, I draw my neckline (which often acts as one of my tramlines), and then draw my equidistant parallel lines to give me likely targets for profit-taking.

I don't want too many lines on your chart, especially if I draw in the Fibonacci retrace levels as well. I generally keep two charts going on the same market and switch back and forth, especially for short-term trading.

NB: Don't miss my next bit of trading advice. To receive all my spread betting blog posts by email, as soon as I've written them, just sign up here .



Spread betting

Boeing's share price plummets: here's how to play it

Boeing shares have fallen by a third this year. But there could be worse to come. Matthew Partridge explains how traders should play it
10 Feb 2020
Share tips

How my 2019 spreadbetting tips fared

Matthew Partridge reviews performance of his 2019 spreadbetting tips. This year’s winners include Bellway, JD Sports and Taylor Wimpey.
17 Dec 2019
Spread betting

Betting on politics: some safe Labour bets

Matthew Partridge outlines a few flutters on what should be safe Labour seats in the general election.
10 Dec 2019
Spread betting

DS Smith will deliver: here's how to play the share price

Packaging group DS Smith is profiting from the online retail boom. Matthew Partridge explains how traders can play the share price.
3 Dec 2019

Most Popular


A global coronavirus pandemic seems inevitable – are markets still too complacent?

Coronavirus is going global. It’s only a matter of time before it’s classed as a pandemic. John Stepek looks at the markets’ reaction, and explains ho…
24 Feb 2020
Buy to let

Come back buy-to-letters, all is forgiven

The government is winning its war against small private buy-to-let landlords. But who benefits?
23 Feb 2020

Money Minute 24 February: house prices, unemployment and corporate results

Money Minute: previewing the week's most important economic and financial goings on, including the latest house price, and unemployment figures, and …
24 Feb 2020

Is 2020 the year for European small-cap stocks?

SPONSORED CONTENT - Ollie Beckett, manager of the TR European Growth Trust, on why he believes European small-cap stocks are performing well.
12 Feb 2019