With the S&P 500 very close to all time highs, not everything is a buy. These four stocks have recently formed head and shoulder patterns; if the pattern completes it is a classic technical analysis reversal signal. A head and shoulders pattern is created by a swing high, then a higher high, and then a lower high. It shows the stock has lost steam to the upside, and is likely to continue lower. The pattern is only valid if it completes though--it must break below the support of the formation in order to signal further downside. 

AECOM Technology (NYSE:ACM) has been forming a head and shoulders pattern for much of the year. The left shoulder occurred in march, followed by the high (head) at $35.24 in August and right shoulder peak recently formed in October. $28 is support for the pattern; a close below that level signals a decline to $21. The target is attained by taking the height of the formation, and subtracting it from the breakout point. In this case, $35.24 minus $28 for an approximate move of $7. $28 minus $7 gives the target of $21. If the price stays above $28 the pattern is not complete, and the stock will continue to move within the $7 range it has been trading in, until that price range is broken.

Mas Tec (NYSE:MTZ) has a very similar structure to AECOM. The left shoulder formed in March, the head in August and the right shoulder started in October. Support for the pattern is $30, so a close below that signals a decline to $25. Until the price drops below $30 the pattern is not complete. If the price can't break through $30 it will continue move in the $5 range until the high or low of the pattern is broken.

Enbridge Energy (NYSE:EEP) has a support range for its head and shoulders pattern. The stock has found support between $29 and $28, therefore the pattern isn't officially complete until it breaks below $28. The recent price action and drop below $29 indicates a high likelihood that break will occur. The pattern is $4 to $5 high, providing a target range between $25 and $23 depending on which low is used as the breakout point, and which is height is subtracted from that breakout point. The $24 region, unadjusted, is the most likely target if the pattern completes. On the other hand, if the support range holds and the price moves back above $31.50 it could try to test the $33.49 high.

Federated Investors (NYSE:FII) has formed a head and shoulders over the last five months, after a strong run up in May. Support for the pattern is $26. A closing price below that signals a likely break, although intra-day lows extend down to $25.72. Subtracting the pattern height of $4.50 (rounded down) from $26 and the target is approximately $21.50. Failure to break below $26 means the stock will channel between $29 and $26 until one of those levels is broken.

The Bottom Line

Head and shoulders are patterns, and not necessarily trade signals. While it is likely that if the pattern completes the overall direction will be lower, trades must still be within your personal risk tolerance. Stop losses should be utilized, traditionally placed just above the right shoulder. A stop could also be placed above the head, but this increases the risk of the trade. Targets should be used as approximations, as all figures for these stocks have been rounded. It is possible the price may fall short of, or exceed, the estimated target.

Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.

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