Head-and-Shoulders Formation?

Q. What is the Head-and-Shoulders Formation?


A: This is considered by many traders to be one of the most reliable analytical tool available and is becoming increasingly popular among traders as an indicator of a sizeable market reversal. The pattern is developed from three rounded bottom formations situated such that the middle one is higher than the other two, both of which are sitting at approximately the same level. The resulting configuration resembles a person's head and shoulders. The formation indicates the end of an up-trend in the market; while the reverse head-and-shoulder formation indicates the end of a down trend.

Q. I've been trading head and shoulders patterns, however my trades get missed on the breakout...

Lately, I have been trading the head and shoulders patterns, however my trades get missed on the breakout, I'm noticing that the majority retrace but not to the support of the breakout day and then typically trend or gap up again at least to the height of the right shoulder and neckline. I'd like to take advantage of this. Any idea on how to lay out an indicator that would give me a bottom on the retracement?

A: Generally when spread traders want an indicator to show them when a move is potentially running out of steam they will use momentum indicators like the MACD or stochastics and look for divergences in momentum. An example of this would be when price makes a lower low but the momentum indicator does not. I would add that some use Fibonacci numbers to predict retracement levels. Note that the most commonly used momentum indicators are the relative-strength index (RSI), the stochastic oscillator, and moving-average convergence/divergence (MACD). The calculations behind indicators may be complex but you don't need to worry about that (just make sure you understand how to interpret the output) as your charting package will do all the work for you.

 ...Continues here - Commodity Channel Index (CCI)

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