When you take the price of a stock and graph it on a chart, you will get chart patterns. These patterns are of importance to traders and technical analysts. The different patterns that are formed give insight about the stock and how it may perform in the future. Technical analysis takes the information found in stock charts and looks at the patterns that are formed. When trading stocks, investors will want to know when is the best time to buy or sell a stock. By deciphering chart patterns, they can locate areas where their stock picks may reverse.
There are a number of patterns, all with different meanings, and if you want to maximize the rewards from investing in the stock market, you should try familiarizing yourself with them. One of the popular chart patterns is the head and shoulders pattern. This pattern is formed when the stock rises to a peak then declines again. It then rises a second time, passing the previous peak and once again declines. It then rises for a third time, but the third peak is lower than the second. These three peaks when viewed on a stock chart will look similar to a head and shoulder.
There are two types of head and shoulder patterns. A “head and shoulder top” signals that the price of a stock may be set to fall. This pattern will appear at the top an upward trend. An inverse head and shoulder pattern is the opposite of the former; it signals that the price could be set to rise. This pattern will appear at the bottom of a downtrend. If you are stock picking with the intent to buy, look for chart patterns with an inverse head and shoulder to take advantage of the rise in price. If you are holding stock, keep an eye open for the head and shoulder top as a sign to sell.
The head and shoulders top chart patterns are based on the peaks and troughs analysis from the Dow Theory. In technical analysis, this trend reversal pattern is normally found at the end of an uptrend, and may be followed by a decline in price. It is not set in stone that the stock must decline after the third shoulder. Instead, it could increase and rise again. You can combine this analysis with another technique to verify the results of the first method.