• Trading 101: Head & Shoulders Bottom?

    by  • May 24, 2013 6:00 am • Trading 101 with Peter Bryans • 4 Comments

    Everyone loves to talk about Apple (AAPL) and this stock happens to be at the center of this post. I’m not focusing on AAPL because it’s a popular stock, but rather because it is at a critical juncture (and arguably has been for some time now) as it is potentially forming what is known as a head & shoulders bottom. This is considered a very strong reversal pattern, and we can see it on AAPL’s daily chart.

    The head & shoulders bottoming pattern is a pattern that many will talk about—probably because it is perhaps one of the most recognized patterns out there. Take a glance at the daily chart of APPL that I have presented below. The lines that I have drawn on the chart clearly show where the left shoulder, right shoulder, head, and neckline have been established. AAPL hit a new all-time high in September of last year, when it traded at ~$705 per share. It also traded at a new 52-week low when it hit the ~$385 mark. This $385 level coincides with the bottom of the “head” in this pattern. This is absolutely a pattern that many traders have their eyes on.

    (courtesy of eSignal)

    Right now, it looks as if the right shoulder is forming—and if we want confirmation from this bottoming pattern, we will need to see a surge to the upside. Volume is always a key element to these types of patterns, and we can see the huge pickup in volume right as AAPL bottomed and continued its ascent to the right shoulder. If this truly is the bottom for AAPL, then we need to see a break of the neckline, and an even stronger move higher. A general rule with these patterns, when measuring the “expected” move, is to measure the distance from the head to the neckline. Based on some so-so drawing techniques (on my end) let’s say that I have the head right around ~$400 and the neckline around ~$460. This is a distance of approximately 60 points (we’ll keep the math simple). If AAPL does indeed break above this neckline, and makes another charge higher, somewhere around $520 is a logical (and entirely possible) price target (remember: these are rough estimates).

    A few final points on this particular chart (and many H&S patterns on charts in general): First of all, nearly everyone out there seems to be watching this particular pattern. AAPL is already one of the most popular stocks in the market, and this pattern is “clear as day” on one of the most looked upon timeframes to begin with (daily timeframe). What I have learned (and I learned this rather quickly) that with the market, when everyone is looking at the same thing, or expecting one thing to happen, it generally won’t pan out that way. We could even see a “nasty” reversal to the downside, and AAPL could make an even lower close than $385. That being said, sometimes these things do play out as expected. If you happen to be on the winning end of this trade, just make sure that your timing was optimal. Personally, I’m not ready to say that the bottom in AAPL was put in at ~$385. This pattern just seems “too obvious” to me. That being said, I could also be completely wrong—this is what’s so much fun about this game. Good luck trading out there.

    About

    Peter Bryans joined the Schaeffer's Investment Research trading team as a Trader in April, 2012. A graduate of the Fisher College of Business at The Ohio State University -- where he concentrated in Finance -- Peter previously held internships with an insurance broker and a wealth-management firm. In his current role, Peter trades a variety of our real-time option services and also hosts our "Options Apprentice" weekly webinar presentations.

    http://www.schaeffersresearch.com

    4 Responses to Trading 101: Head & Shoulders Bottom?

    1. sir_quasar
      May 25, 2013 8:47 pm at 8:47 pm

      Scott has a valid point. Your labeling of the left shoulder is in error and should actually be the low made at the first of March. This is especially true if you are going to use the neckline as you have it indicated since the left shoulder should come before, not after, the left neckline point. This may or may not be a matter of semantics, but I’ve found the best H&S formations have a certain sense of rhythm/uniformity/symmetry about them which this chart has yet to complete. One more downward lunge without exceeding the head would give a more satisfying chart completion IMO.

      • Peter Bryans
        May 26, 2013 1:24 pm at 1:24 pm

        Fair enough. I think that recognition and continued observation are more important than the exact metrics of the pattern itself.

        Thanks for your insight and thanks for reading.

    2. Peter Bryans
      May 24, 2013 12:17 pm at 12:17 pm

      Good question–

      That could actually be considered the left shoulder if you want to look at it that way. This would then mean that the right shoulder has a lot of “work” to do before the pattern is completed.

      You’ll quickly learn that with these kinds of patterns, they are often very subject to the individual’s own interpretation. Basically, you will see whatever it is that you want to see. But that could be an entirely different blog post….

      Hope this answer helps.

    3. Scott Frantz
      May 24, 2013 10:03 am at 10:03 am

      Why wouldn’t the left shoulder be the broader dip starting in March? Why is it the next dip? Just curious and trying to learn…

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