Fly Fishing the Stock Market: How to Search for, Catch, and Net the Market's Best Trades

THE DECEPTIONS OF HEAD-AND-SHOULDERS

The head-and-shoulders pattern is among the greatest attractions in the market, tempting many traders to place their bets on a seemingly sure thing. But does this pattern always deliver? According to Encyclopedia of Chart Patterns by Thomas N. Bulkowski, only 7 out of 23 head-and-shoulders patterns succeed in reversing the uptrends.

These popular patterns lure inexperienced traders with their promises of what looks like easy money. You need to heed the warning signs to avoid getting trapped on the wrong side of a trend. Take a look at how the shorts got squeezed in AMLN (Figure 6.10).

FIGURE 6.10 A head-and-shoulders top fails to deliver a decline.

AMLN, daily, indicator set #8. Capping an uptrend, AMLN has traced the left shoulder (LS), the head (H), and the right shoulder (RS). Afterward, prices sold down in area C. This is where the latecomers went short, thinking the neckline would break. They did not recognize the bullishness building beneath the surface.   • A sharp sell-off started in area A, taking prices to a low in area B.   • That low was retested in area C, forming a neckline. The Impulse system changed from blue to red for only two days.   • Prices then entered a consolidation pattern in area D. Notice low volatility (represented by short price bars). This is more typical of reversals than continuations.   • Bargain hunters stepped in, and the pros began to cover on bar E.   • A short squeeze began to feed on itself, as weak shorts ...