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One of the most reliable chart formations is the
head-and-shoulders top or bottom. This easily recognizable chart
pattern signals a major turn in trend. The main advantage of
the head-and-shoulders pattern is it gives you a clear-cut objective
of the price move after breaking out of the formation. Measure the
price distance between the head and the neckline and add it to the
price where the neckline is broken. This projects the minimum
objective. Although the head-and-shoulders gives no time projection,
it predicts a very strong trend in the future.
In most cases, a head-and-shoulders formation will be symmetrical,
with the left and right shoulders equally developed. Although the
neckline doesn't have to be horizontal, the most reliable formations
stray only a little.
Flags and pennants are consolidation patterns which give objectives
for further moves. As the formation develops, price action in an up
trending market will look like a flag flying from a flagpole as prices
tend to form a parallelogram after a quick, steep up move. Flags "fly
at half-staff." The more vertical the flagpole, the better.
A price objective is obtained by measuring the flagpole and
adding it to the breakout point of the formation. The flagpole should
begin at the point from which it broke away from a previous congestion
area, or from important support or resistance lines. Flags in a down
trending market look like they are defying gravity and slant upward.
A pennant also starts with a nearly vertical price rise or fall. But,
instead of having equal move reactions in the consolidation phase like
a flag, pennant reactions gradually decrease to form short uptrend and
downtrend lines from the flagpole.
The same measuring tools used in flags are used in pennants. Add the
length of the flagpole to the breakout point to get the minimum
objective. Remember, flags and pennants are usually continuation
patterns in an overall trend which resumes after the breakout of the
consolidation area.
Also, the coil formation, or symmetrical triangle, appears
while prices trade in continually narrower ranges, forming uptrend and
downtrend lines. This pattern doesn't tell you much about the
direction of the next move. After breaking one of the trend lines, the
objective is found by adding the width of the coil's base to the
breakout point.
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