The Head-and-Shoulders Formation
by Thomas Bulkowski
I was doing research in the public library when a staffer asked me if I could help an elderly lady find a chart of TWA [TWA]. The investment materials are sparse at the library and the periodicals that were available didn’t have what she needed. The library does have an Internet connection, how-ever, so we went surfing looking for a Web page to chart the stock. Within minutes, we had printed out what she was looking for.
Before the ink was dry, she asked me if I knew anything
about charts. I told her I did, a little, at which she pointed to the printout and asked, “Is that a double top?” (Figure 1). That was when I looked at the chart and immediately noticed a head-and-shoulders formation. She was, she told me, considering either adding to her position or selling it completely: A typical investor quandary. Figure 1 shows how unlucky she was at having purchased her first lot in early 1996 and riding the head-and-shoulders reversal down. The stock recently changed hands at about $6.
Have you ever lost money suffering through a head-and-shoulders reversal? Here’s a primer on one of the better-known chart patterns that signal major bottoms and tops.
Sometimes it pays to follow more than one stock in an
industry to help gauge its health. Research indicates that
industry behavior accounts for 15% to 20% of a stock’s price
fluctuation. Other factors also influence the stock’s price:
The economy (30% to 35%), the company (30% to 35%) and
other factors (15% to 20%).
Such was the case with Cirrus Logic Inc. [CRUS], seen in Figure 2. The chart shows two examples of a head-and-shoulders top. Along with Cirrus, Chips and Technologies [CHPS] and VLSI Technology Inc. [VLSI] both had a head-and-shoulders formation appear during the last quarter of 1996. Charts of the three companies, when taken together, indicated growing weakness in the semiconductor industry. They served to warn the astute investor that the bottom was about to drop out of the high-tech sector.