The Continuation Head and Shoulders Pattern

We treated the head and shoulders pattern at some length and described it as the best known and most trustworthy of all reversal patterns. The head and shoulders pattern can sometimes appear as a continuation instead of a reversal pattern.

In the continuation head and shoulders variety, prices trace out a pattern that looks very similar to a sideways rectangular pattern except that the middle trough in an uptrend tends to be lower than either of the two shoulders. In a downtrend, the middle peak in the consolidation exceeds the other two peaks. The result in both cases is a head and shoulders pattern turned upside down. Because it is turned upside down, there is no chance of confusing it with the reversal pattern.

The principle of confirmation is one of the common themes running throughout the entire subject of market analysis, and is used in conjunction with its counterpart-divergence. We'll introduce both concepts here and explain their meaning, but we'll return to them again and again because their impact is so important. We're discussing confirmation here in the context of chart patterns, but it applies to virtually every aspect of technical analysis. Confirmation refers to the comparison of all technical signals and indicators to ensure that most of those indicators are pointing in the same direction and are confirming one another.

Divergence is the opposite of confirmation and refers to a situation where different technical indicators fail to confirm one another. While it is being used here in a negative sense, divergence is a valuable concept in market analysis, and one of the best early warning signals of impending trend reversals. We'll discuss the principle of divergence at greater length in "Oscillators and Contrary Opinion."