Even if you do not follow chart patterns, you may be familiar with the head-and-shoulders top or bottom pattern. For head-and-shoulders tops, the pattern looks like the profile of a person from the shoulders upward. The bottom version has the profile flipped upside down. If you need more information on them, then click on the associate link.
The large image to the right gives an idea of what a head-and-shoulders top pattern looks like. I conducted research on shoulder symmetry and found some interesting results.
- Head-and-shoulders patterns with an extended right shoulder tend to perform less well. The middle image in the figure shows an idealized example. The right shoulder is farther away from the head than is the left shoulder. The top image shows the two shoulders equidistant from the head. Patterns with an extended left shoulder (bottom image), tend to outperform.
- The more unsymmetrical a head-and-shoulders top appears, the better it performs. I like to think of this as ugly patterns work best, but it varies from pattern to pattern. This finding is a variation of the prior bullet item because it uses a range for symmetrical patterns. For details, read the study.
In the study, I am comparing head-and-shoulders tops that appear symmetrical about the head (approximately equal distances from shoulder to head) to those not symmetrical. The farther the ratio of the two shoulder distances gets, the better the performance.
- The more symmetrical a head-and-shoulders bottom appears, the better it performs. This is the same as the prior bullet item except that it pertains to head-and-shoulder bottoms. The results also flip. Again, I am using a ratio of the distances from the shoulders to the head. The ugly head-and-shoulder bottoms perform worst.
- The smaller image shown above right compares the height of the two shoulder peaks in a head-and-shoulders top chart pattern. Patterns in which the left shoulder is above the right one shows better performance after the breakout. Shoulders that share the same price have the worst performance. Those patterns with a higher left shoulder see declines that average 25% compared to declines of 20% for higher right shoulders and 19% for even shoulders.
- For head-and-shoulders bottoms, the next image shows the configuration that works best. A higher left shoulder valley when compared to the right shoulder valley results in a larger rise postbreakout, but the difference is small. In a bull market those patterns with a higher left shoulder see rises averaging 39% compared to 37% for head-and- shoulders bottoms with lower right shoulder low, and 37% for those with even shoulder lows.
A neckline is a trendline that connects the two armpits of a head-and-shoulders pattern. The findings for this are simple and they relate to slope of the neckline.
- Head-and-shoulders bottoms with down-sloping necklines show outstanding performance, 42% versus 34% for trendlines that either slope upward or are horizontal.
- Head-and-shoulders tops with horizontal necklines outperform, but the difference is minor, -24% to -23% (up-sloping) and -21% (down-sloping). The minus signs mean a drop after price stages a breakout.
These results can help you pick which head-and-shoulders pattern to trade, given that everything else is the same. Choose the configuration that has the highest performance. Your selection may be a dud anyway because you area dealing with probabilities. However, information such as this gives you an edge over other traders. Sometimes that edge is all you need to slice your way to higher profits.
-- Thomas Bulkowski