Shoulder Head Shoulder definition
One of the best known trading figures for Technical Analysis is Shoulder-Head-Shoulder, which is named in all the books about that kind of analysis.
Everybody say it is a very effective indicator although I have my doubts about it.
This “indicator” would be something like this:
Imagine we have a daily or weekly bars chart of any stock.
That stock has a maximum price and recedes some weeks later, forming a temporary minimum, after which starts rising again.
This time the stock rises more than the previous maximum giving us a second maximum price, after which the price starts going down again until it gives us a sort of temporary minimum price.
Later the price will rise again but it will not go over the last maximum price, forming a third temporary maximum lower than the previous but approximately similar to the first one.
Therefore we have three temporary maximum prices, being the middle one the highest of them and being therefore the “head”.
The two other maximums will be the “shoulders”.
The best thing is to see it in a chart so we can understand better.
Nothing better than a real case to see it.
In this case we have Apple around 2012 when it had a shoulder-head-shoulder that, without being perfect, was very acceptable to see how the thing works.
As we can see the stock did something similar to what I tried to explain just before.
Notice that this process takes a long time in a long-term chart like this. We should wait for months to see this.
Finally, there was a breakdown of the second shoulder when the stock gave us an acceptable “sell signal”.
What is the problem of the Shoulder-Head-Shoulder figure?
The problem is that the pattern does not always confirm itself, much less in bear markets.
In most cases we will have a good signal for every bad signal, so to speak.
The problem with the example I just gave is that it is not very recommendable to trade the short side of the stock market, when the stock markets remain bullish 80% of the time.
However, a better way to use something like this would be using the inverted version of this, which would work when a stock is making new lows.
The matter would be the same.
We would just need to look for a similar figure in the contrary side.
The objective is finding a “point” where the stock is giving us a early bullish market signal.
An example of this we can see in Mastercard in the bear market of 2008.
As we can see, this stock formed almost a perfect inverted shoulder-head-shoulder figure.
AS we can see, after this figure, the stock started a long bull market.
This kind of figure is quite common when the minimum price of bear markets occur.
Of course this figure does not need to be perfect.
Shoulder-Head shoulder for other financial markets
The great majority of people who knows this figure and tries the adventure in this derivative markets and other assets that are not stocks think that it is possible to apply it to those markets as if it can work the same as it does in stocks.
I am afraid but the majority who try this will not take too long time to realize that this strategy does not work in all markets because they are much more erratic than stocks, which, remember, tend to have a bullish trend.
It is even worse when people try to apply this figure to the short term trading strategies regarding day trading, in which they will find this figure a lot of times in their 5 and 15 minutes charts.
That is, however, a visual tramp, since doing so we will find out that almost half of those figures give us “false” signals.
Anyhow, other indicators will not work either in those day trading markets.
That is why we should use this figure as a help tool.
Once we have spent many years analyzing graphs and charts and after many bear markets, you will eventually see that it is in the long-term charts where this kind of indicator or figure gives us better prospects.