Why is the (i)-Head & Shoulder a bonafide reversal pattern?

They dont teach this in the textbooks

Jan 20, 2024

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“The real voyage of discovery consists not in seeking new landscapes, but in having new eyes.”
― Marcel Proust

I wanted to take this opportunity to share with you my learnings of the last 1 month or so.

But that can wait.

Today I will explain to you the logic behind, why (i)Head & Shoulders (iH&S) is a bonafide reversal pattern, irrespective of a prior trend.

Before I begin, I will ask you to forget anything that you have learned from Twitter or the book for the time being and keep an open mind.

TA lesson No.1: What does a stock do at any point in time?

Ans: It bases, or trends.

First, what is an (i)H&S pattern?

Just Google this part.

But in short, it’s a price pattern that looks like the head and shoulder of a man (or a woman).

The model iH&S has a horizontal resistance. A head, which is the lowest pivot-low, 2 shoulders on either side of the head at similar price levels that are higher than the head.

The BIG question is, how is this a reversal pattern?

What is it reversing?

Let me explain this with the help of a newly listed stock which takes the shape of an iH&S meaning that it won’t have a prior trend.

At the end of the explainer, you will be convinced that this is how iH&S is reversing a downtrend.

(Similarly, an H&S will be reversing an Uptrend)

What is the iH&S reversing?

Imagine a new stock listing.

Lists at 100.

goes to 95 in some days.

what is it doing?

It is trending.

What’s the trend?

It’s on a downtrend.

Okay. Glad you agree.

But we still do not have a base. why?

Because we do not have a pivot low yet.

Okay so then what happens?

The stock reverses from 95. Yay!

we have a pivot low finally (just google this jargon for now).

Now we have a base. how come?

We have a pivot high (100) and a pivot low (95).

Remember a base will have a range. we have got it for now.

What happens next?

Stock rallies to the pivot high (~100), but finds resistance and cannot print a new high.

So that means?

That means we are inside the bigger base (100-95 range wala base).

Okay, what’s next?

Price comes down after hitting resistance.

As long as the price is within the range (yes, this 100-95 wala), we are still basing.

What happens next though?

The price breaks down from the base, making a lower low and starting a nascent downtrend. I repeat. A nascent downtrend.

At this point how the chart looks is what most stocks look like when they begin their long-term downtrend.

It all begins from a 1st lower low.

But let’s continue. What happens next?

We soon have a pivot low at around 92 (as the stock bounces back from that point).

The stock breaks inside the base powering through the 95 levels and heads towards the prior resistance of 100.

It faces resistance again and starts dropping again.

Since this is not a lower high. The nascent downtrend is negated. But only for the time being. Had it been a lower high than 100, it would have been a lower high and we would be still in a downtrend. If the price hits a lower pivot low (lower than 92), the downtrend continues.

But where does it drop back to?

Where is the new pivot low?

Is it below the previous pivot low (92) or above that level?

well,

This time, the price doesn’t drop back to 92 but finds a pivot low at around 95.

A pivot low that is a higher low than the previous pivot low.

How exciting!

We have a higher low.

We are basing now.

The new range: 100-92

But are we in an uptrend yet?

Not yet.

For an uptrend, we need a higher High (this you will find in the books. simple Dow theory and all).

That soon comes when the price bounces back from 92 and crosses beyond 100.

This is a breakout of the iH&S base.

This is the beginning of a nascent uptrend.

At this point how the chart looks is what most stocks look like when they begin their long-term uptrend.

It all begins from a 1st higher high.

Now,

This is what all iH&S looks like.

No matter whether there is a prior trend or not.

If there is, no matter if that is an uptrend or a downtrend.

Each time an iH&S occurs, it reverses a NASCENT DOWNTREND to a NASCENT UPTREND (and H&S reverses a nascent uptrend to a nascent downtrend).

Therefore my friend, even if they might have forgotten to write this in the textbooks or research papers, (i)H&S are BONAFIDE reversal patterns.

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That's all for today.

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