The NASDAQ was slightly down for the week with a fall of just 0.1%. Monday's gap up was promising, but it was downhill from there leaving the index in a possible bearish head and shoulders top formation. The neck of the left shoulder (blue line on the chart below) provided support on Wednesday and our trend indicator remains positive. The possible head and and shoulders top pattern (HST) will be confirmed as bearish if the price line falls through the blue line at 4842. The probability of this is 58% based on our analysis of 8,700 HST patterns in our database. To learn more about how we recognize a head and shoulders top, see our top tip below.

The markets were closed on Friday and could not react to the disappointing job data. The downturn almost certainly further delays any increase in interest rates by the Federal Reserve, to which the markets may react positively on Monday.

Watchlists now show that they are for trading at the next session. Previously we showed the date on which the  watchlists were prepared, which created some confusion.
 

How to Recognize a Head and Shoulders Top Bearish Pattern

The head and shoulders top pattern (HST) is recognized as one of the most reliable bearish trend reversal patterns. Our data for  8700 HST patterns since 2006 shows that it is successful 58% of the time but reaches its target price just 30% of the time in the first 28 days after breakdown. This is less successful than we previously reported in our  Newsletter Archive. On reaching the breakdown price, the stock continues to fall in 68% of the cases.

An HST pattern forms after an uptrend and is characterized by three peaks with the center peak higher than the two adjoining peaks. The neckline is a line drawn between the two intraday lows between the peaks.

We recognize two types of head and shoulder top, depending on the slope of the neckline. We do this so we can recognize a breakdown price and issue alerts when this price is met.

When the neckline is flat or slopes upwards, the breakdown price is calculated as the point where the neckline intersects the price line following formation of the right shoulder. It is at this point that the pattern is completed and a long position should be closed, or a short position opened. At this time we can calculate a 'target' decline which is the distance between the center peak's high and the neckline.

If the neckline slopes down, then it is possible that it will never intersect the price line following the right shoulder, so we use an alternative method of determining a breakdown price. In this case we use the support level between the left shoulder and the head and calculate the target price as the difference between that support level and the center peak's high.

Pattern Recognition

Our algorithm will recognize a head and shoulders top pattern when the following conditions are met.

1. The stock must be in a confirmed up trend before the pattern begins. An uptrend exists if the the left shoulder is at least 30% higher than the low in the previous 6 months (120 trading days).
2. The pattern width, shoulder-to-shoulder, must be 6 months (120 trading days) or less.
3. The head must have occurred within the last 6 months (120 trading days).
4. There must be approximate symmetry to the pattern. We determine this by requiring that number days between the shoulders and the head (a and b in the diagram) must be within 50% of each other.
5. There must be a noticeable trough between the left shoulder and the head (c). We chose an arbitrary minimum of 2%. This is measured from the left shoulder intraday high to the intraday high at the left neckline.
6. There must be a noticeable trough between the head and the right shoulder (d). We chose an arbitrary minimum of 2%. This is measured from the right shoulder intraday high to the intraday high at the right neckline.
7. For upward sloping necklines, the breakdown price is the the neckline value on the date of the last close.
8. For flat or downward sloping neckline, the breakdown price is the value of the intraday low at the left neckline.
9. The last close must be above the breakdown price.
10. The minimum 50 day average volume must be at least 500,000. Stocks with greater liquidity are less likely to make sudden moves creating a short squeeze.