The Head and Shoulders pattern (H&S) is a classic topping pattern, where the stock makes two successive new highs, but then fails to make a new high on the third attempt. This often indicates that the stock is headed for a decline, but only if the pattern actually "breaks." These four stocks are near H&S breaking points, which is the entry for the trade. Since the H&S is a topping pattern these are all potential short trades, but with major indexes at all times highs, including the SPDRs S&P 500 (ARCA:SPY), taking on short positions does warrant some caution.

PulteGroup (NYSE:PHM) broke below its H&S pattern on July 25 when the stock gapped lower. A price objective is obtained by taking the height of the pattern and subtracting it from it from the breakout price. With the breakout occurring very near $18, and a pattern height of $6 (rounded down), the price target for the decline is $12. I'd place a stop loss near $20.75, which is just above the latter high of the right shoulder. An alternative entry is to wait and see if the price rallies to test the breakout point near $18, and then enter a short in that vicinity. This option provide a better risk/reward, but if the stock doesn't test the breakout point then the trade is missed. 


Autodesk (Nasdaq:ADSK) actually broke out of its H&S pattern back in May, but the rally in July has brought the price back back above the breakout. This "second chance" trade is fairly common with H&S patterns, and one benefit is that the risk is slightly less because the price is above the breakout point (and original entry price). Before entering short though I'd like to see the stock drop below minor support at $35.95. If that occurs the price target is $31. There are multiple stop levels I believe are good choices, although $38.50 is the one I prefer.

Taiwan Semiconductor (NYSE:TSM) is in a similar to position to Autodesk, in that it broke out earlier, but has rallied back to near the breakout point. If the price drops back below $16.68 I like the short trade, with a target of $13.50. Placing a stop at $19 is ideal, but just above $18.30 is likely also fine as it is just above a gap which occurred during the right shoulder.

Martin Marietta Material (NYSE:MLM) broke below the H&S breakout point on July 30, and closed nearly right on it after a wide-ranging sell-off day. Before taking a short position I think the prudent choice is to wait for the price to drop below the July 30 low at $95.64; this will provide some confirm that there is still selling pressure. The orginal breakout/entry price is just below $98, and is still valid. though. The target for the downside move is $79 with a stop-loss just above $107.

The Bottom Line
The head and shoulders pattern is a classic topping pattern, often indicating that the price will continue to slide once the pattern completes. Of course that doesn't mean the stock will always drop. That's why a stop loss order is used to control risk. The profit target is an estimate of where momentum could take the price, it is not meant to pinpoint an exact low or reversal point. Also, since H&S patterns can take months to form, reaching the profit target may also take as long.

At the time of writing, Cory Mitchell did not own shares in any of the funds mentioned in this article.

Charts courtesy of

Related Articles
  1. Active Trading

    Using Trading Indicators Effectively

    Select multiple indicators, avoid information overload and optimize indicators to effectively use technical analysis tools.
  2. Forex Education

    Trading Is Timing

    Learn how to make gains even if you don't get in at the right time.
  3. Investing Basics

    Buy-And-Hold Investing Vs. Market Timing

    If volatility and emotion are removed, passive, long-term investing comes out on top.
  4. Active Trading

    Combining Trend-Following and Countertrend Indicators

    In the long run, one of the best approaches to successful trading might be melding these two seemingly disparate methods together.
  5. Mutual Funds & ETFs

    Master Futures Trading With Trend-Following Indicators

    The futures market is a lot less scary when these indicators are used to establish current trends.
  6. Budgeting

    The P/E Ratio: A Good Market-Timing Indicator

    Check out the returns this newer technical analysis tool would've yielded over the period from 1920 to 2003.
  7. Active Trading

    Market Timing Fails As A Money Maker

    This strategy is popular, but can you do it successfully?
  8. Active Trading

    Timing Trades With The Commodity Channel Index

    We introduce how to use this oscillator, which identifies cyclical trends, for determining buy and sell points.
  9. Chart Advisor

    ChartAdvisor for November 27 2015

    Weekly technical summary of the major U.S. indexes.
  10. Chart Advisor

    Pay Attention To These Stock Patterns Playing Out

    The stocks are all moving different types of patterns. A breakout could signal a major price move in the trending direction, or it could reverse the trend.
  1. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  2. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  3. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  4. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
  5. Do Vanguard ETFs require a minimum investment?

    Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment ... Read Full Answer >>
  6. Can mutual fund expense ratios be negative?

    Mutual fund expense ratios cannot be negative. An expense ratio is the sum total of all fees charged by an asset management ... Read Full Answer >>

You May Also Like

Trading Center