Bulkowski on Head-and-Shoulders Bottoms

This is an example of a trading trap. After a multi-peak pattern (underlined in red), a bullish chart pattern appears. In this case, that's the head-and-shoulders bottom. The chart pattern breaks out upward and price rises a minor amount before reversing, ending in a failed trade.

Not all multi-peak patterns will fail, but the odds of success are diminished.

This chart shows the stock climbing in a straight line run at A. The stock peaks and retraces in a straight line run down (B) to form the left shoulder of a head-and-shoulders bottom. The head-and-shoulders bottom breaks out upward and the stock joins the uptrend again. This is a winning trade.

I don't know if strong up and down trends leading to a chart pattern are the ingredients for success, but it's something to look for.

This is another example of a rise-retrace trade, but one that ends in failure. The up and down trends leading to the head-and-shoulders look loose and wandering, not straight-line runs as in the prior example. This trade fails to reach the target and ends as a loss.

CLX, from 6/3/2013 to 7/3/2013 (not shown), but a straight-line run up precedes a sloppy, loose looking decline into a head-and-shoulders bottom. The trade also failed, so do be careful taking a position after an uptrend.

In this example, price makes a strong push lower, following the tall red line. The stock breaks out upward in a tall price bar. However, expect a retrace after that tall bar and that's what we see happen. Indeed, the trade fails.

Other trade failures in a strong downtrend like that shown here are in CRL from 9/22/2011 to 10/18/2011, CMCO from 8/25/2015 to 10/30/2015, and CMI from 7/17/2015 to 8/4/2015. In the last example, the downtrend isn't steep until about 2 weeks before the head-and-shoulders starts.

When I first saw this setup, I thought Yes, it'll work, and it did.

I consider this an ugly double bottom with bottom B above bottom A. Usually my criteria for a valid pattern means that B is at least 5% higher than the price of A. I didn't bother to check that this time. When the head-and-shoulders bottom breaks out upward at the blue dot, enter the trade and ride price higher.

When I looked at this chart, I saw overhead resistance setup by the price trend that loosely follows the green line. That resistance would post a barrier to an upward move after the breakout from the head-and-shoulders bottom. In this example, the chart pattern did NOT breakout upward. A breakout would require a close above the red line, which didn't happen. Indeed, the stock tumbled.