Head & Shoulders Top Watchlist Trading Hints

We published an analysis of Head and Shoulders Top breakdowns in our newsletter of 7/29/06. We found that a breakdown occurred in 96.38% of cases. This indicates that the head and shoulders pattern is a very powerful predictor of a price decline to come. This is true whether the slope of the neckline is upwards, flat or downwards. Of these, the decline after breakdown exceeded 5% in 74.5% of breakdowns.

Upward sloping necklines are much more common than downward sloping necklines and have a slightly higher potential return by about 1%.

As with the 50 DMA breakdown watchlist, our suggestions are based on my analysis of the results quoted, areview of the literature and the experiences of a short sale hedge fund manager

Short selling is risky because your potential loss is unlimited. When going long, the maximum amount you can lose is your initial investment, when shorting there is no limit to how high the stock can go from your entry level, so cover quickly when the stock moves against you.
Review the H&S Top watchlist prior to the market open to select stocks you would consider shorting if an alert is issued.
Set a target cover price (see methodology tab) before you go short, using either a fixed percentage or an expected support level, and take profits at that level.
If you go short on an alert and the stock recovers above the support level by the close, consider covering your position immediately.
If you go short on an alert and the stock closes below the support price but volume doesn't meet the 1.5 times adv requirement, don't cover but wait for the action on the following day.
Cover when a support level is tested and found to hold.
Don't bet against the market.

If you hold a long position in a stock that has completed the right shoulder of an H&S pattern, then you should sell because 96% of these stocks will break down.

Because of the high probability that a breakdown is about to occur, you may wish to open a short position immediately an H&S is identified before waiting for the breakdown. The position can then be added to when the breakdown occurs.

Immediately after the breakdown, set a stop loss at the breakdown price to protect yourself against the 17.6% of breakdowns that recover the next day. Otherwise, a reasonable target profit for the trade is 70% of the target price.