Volume top at Head and Shoulders

THE IMPORTANCE OF VOLUME

The accompanying volume pattern plays an important role in the development of the head and shoulders top as it does in all price patterns. As a general rule, the second peak (the head) should take place on lighter volume than the left shoulder. This is not a requirement, but a strong tendency and an early warning of diminishing buying pressure. The most important volume signal takes place during the third peak (the right shoulder). Volume should be noticeably lighter than on the previous two peaks. Volume should then expand on the breaking of the neckline, decline during the return move, and then expand again once the return move is over.

As mentioned earlier, volume is less critical during the completion of market tops. But, at some point, volume should begin to increase if the new downtrend is to be continued. Volume plays a much more decisive role at market bottoms, a subject to be discussed shortly. Before doing so, however, let's discuss the measuring implications of the head and shoulders pattern.

FINDING A PRICE OBJECTIVE

The method of arriving at a price objective is based on the height of the pattern. Take the vertical distance from the head to the neckline. Then project that distance from the point where the neckline is broken. Assume, for example, that the top of the head is at 100 and the neckline is at 80. The vertical distance, therefore, would be the difference, which is 20. That 20 points would be measured downward from the level at which the neckline is broken. If the neckline is at 82 when broken, a downside objective would be projected to the 62 level (82 - 20 = 62).

Another technique that accomplishes about the same task, but is a bit easier, is to simply measure the length of the first wave of the decline and then double it. In either case, the greater the height or volatility of the pattern, the greater the objective. The measurement taken from a trend line penetration was similar to that used in the head and shoulders pattern. You should be able to see that now. Prices travel roughly the same distance below the broken neckline as they do above it. You'll see throughout our entire study of price patterns that most price targets on bar charts are based on the height or volatility of the various patterns. The theme of measuring the height of the pattern and then projecting that distance from a breakout point will be constantly repeated.