Knowledge of probability and statistics will allow traders to greatly increase profit possibilities while limiting risk.  But knowledge of math is not required to enhance one’s trading.

Recognizing chart formations acts like recognizing opportunities.  Both opportunities to profit, but also opportunity to avoid bloodbaths.  Stock and option traders can either participate in major moves to their benefit or detriment.  Numerous common technical patterns exist that can be employed to identify favorable entry and/or exit points.

Trend lines, support and resistance are required for any technical assessment.  But these may be considered as just building blocks for more complex patterns.  One of the simplest of these complex chart formations is known as a “Head-and-Shoulders.”

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Made famous by Charles Dow, this major reversal pattern was and has appeared in every major market top or bottom in the last fifty years.  This formation is a precursor to both market rallies and major corrections.  It is accurately described as a “Head-and-Shoulders” top or bottom.

“Head-and-Shoulders Tops” look just like their name implies a “Head” (highest high) flanked by “Shoulders” (lower highs).  Separating the head from either shoulder is the neckline.  Made up of lows of similar time and price formation the “necks” do not have to be identical, but the closer to being a mirror version of each other, the higher the probability for a trend change in the other direction.

Double tops are widely considered as points of great resistance.  Think of a “Head-and-Shoulders Top” as a triple top with the center top having a higher high.  Add to that the fact that the neckline adds a point of support that if broken often foretells a stocks rapid decent.

As with any pattern, there can be a number of small variations.  For example, there may be two or more left shoulders near the same price range, or two or more right shoulders.  In any case, the most important component of the formation is the neckline.  When it is broken, the pattern is complete and a significant change in character often follows.  The following drop is often the most precipitous of the entire formation and occasionally will eclipse the height of the pattern (the top of the Head to the Neckline).  As the new character evolves, successive rallies commonly fail at lower highs until the overall decline is far greater than the magnitude of the initial formation.

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Once a trader learns “Head-and-Shoulders Tops,” they should have an easier time understanding “Head-and-Shoulders Bottoms.”  Basically, bottoms are tops upside-down.  That is, the shoulders are higher than the head and the necks are short-term highs not lows.  “Head-and-Shoulders Bottoms” signal trend reversals with high probabilities of upward price appreciation, bullish reversals instead of bearish reversals.

It’s obvious you should never overlook the potential of a clearly formed and definitely broken trend.  The historical traits of well know patterns demonstrate the ease in profiting from their analysis.  But the difficulty may come from seeing the second shoulder before the opportunity has been diminished.  Experience will help traders see them as they’re formed.

The Beauty of understanding chart patterns surrounds the fact traders can study them without risking their accounts by looking at existing charts.  Study as many as possible.  I hope that my examples have helped.  I hope this article has also helped.

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