Head & Shoulders Bottom Watchlist Trading Hints

Stocks should not be traded simply on the basis that they appear on the Head and Shoulders Bottom (HSB) watchlist. The watchlist provides a basis from which to do further research and there are four requirements before a trade should be entered:

The stock should be either a potential breakout, that is, one on which we've issued an alert, or a confirmed breakout (see below)
The stock should have excellent technical strength (see below)
The stock should have above average fundamental strength (see below)
The market should be favorable to the industry group of the stock (see below)

Our due diligence tools allow you to make these evaluations. We suggest that you use these tools to prepare your own shortlist of stocks to monitor on the next trading day.

The trade may be entered either during the day's trading or at the open on the day after breakout. In general, it's desirable to set a limit price and a stop price.

Our Sell Assistant tool, and/or our Stock Timeliness Checkup tool can be used to time the exit of the trade.

1. Confirmed Breakout

Price should be at least $0.10 above the pivot price (the Breakout Price), AND
Volume must be at least 50% above the average daily volume (the Breakout Volume).

The watchlist provides you with both these values so you can monitor intra-day price and volume movements against these criteria. Gold and Platinum subscribers can receive intra-day email alerts of potential breakouts when it is likely that these conditions will be met.

Even though a stock may meet the price and volume requirements intra-day, the stock is not considered a successful breakout unless both conditions are met at the day's close. Successful breakouts are reported in our daily email and on the Recent Breakouts report.

2. Excellent Technical Strength

Stocks that score a '4' on technical strength are best positioned to make a strong successful breakout, particularly if they also have a Relative Strength Rank of at least 84.

3. Above Average Fundamental Strength

Stocks that score at least a '3' on fundamental strength can do well on breakout. These are stocks that have the potential to score better in the future. Stocks that already have higher fundamental scores tend to have already been recognized by investors and have less upside potential.

4. Market Condition and Profitable Industry Groups

In a bull market, most stocks tend to go up and in a bear market most stocks tend to go down. But in both markets there will be breakouts from a HSB pattern that give exceptional gains. Look at the industry group to which the stock belongs. Whether the market overall is rising or falling, there will be industry groups that are out-performing the market. Our daily market and industry analysis tells you which way the market is trending and our industry analysis tells you which industry groups are outperforming the market.

Intra-Day Trading

Monitoring a stock on the day after it appears on the watchlist may allow you to enter a trade while the stock is in the early stages of a breakout. If the breakout price is achieved and the volume is trending toward, or has exceeded, the breakout volume, then you may be able to enter a position at a much more favorable price than if you wait until the breakout is confirmed at the end of the day.

Trading at the Open

If a stock has successfully broken out at the end of the day, then it may be a candidate for trading at the open the next day, provided it meets the three additional requirements cited above. Stocks that have broken out are reported on the 'Recent Breakouts' report.

Limit Price

In general, a stock should not be purchased at more than 5% above the breakout price. Exceptions can be made if the stock gapped-up on exceptional volume.

Stop Price

After entering a position you should either place a stop order, or, if you can monitor the market in real-time, determine a mental stop so that if the trade goes against you, you will exit the position. While some authors suggest a 7-8% stop loss, we think the stop loss price should be based on the most recent support level for the stock. In the case of the HSB pattern, this is the intra-day low at the 'head'. The stop should be placed just below this level.