A variation of the head and shoulders pattern sometimes occurs which is called the complex head and shoulders pattern. These are patterns where two heads may appear or a double left and right shoulder. These patterns are not that common, but have the same forecasting implications. A helpful hint in this regard is the strong tendency toward symmetry in the head and shoulders pattern. This means that a single left shoulder usually indicates a single right shoulder. A double left shoulder increases the odds of a dou­ble right shoulder.
Tactics
Market tactics play an important role in all trading. Not all tech­nical traders like to wait for the breaking of the neckline before initiating a new position. As Figure 5.3 shows, more aggressive traders, believing that they have correctly identified a head and shoulders bottom, will begin to probe the long side during the formation of the right shoulder. Or they will buy the first techni­cal signal that the decline into the right shoulder has ended.
Some will measure the distance of the rally from the bottom of the head (points C to D) and then buy a 50% or 66% retracement of that rally. Still others would draw a tight down trendline along the decline from points D to E and buy the first upside break of that trendline. Because these patterns are reasonably symmetrical, some will buy into the right shoulder as it approaches the same level as the bottom of the left shoulder. A lot of anticipatory buying takes place during the formation of the right shoulder. If the initial long probe proves to be profitable, additional positions can be added on the actual penetration of the neckline or on the return move back to the neckline after the breakout.
The Failed Head And Shoulders Pattern
Once prices have moved through the neckline and completed a head and shoulders pattern, prices should not recross the neckline
again. At a top, once the neckline has been broken on the down­side, any decisive close back above the neckline is a serious warn­ing that the initial breakdown was probably a bad signal, and cre­ates what is often called, for obvious reasons, a failed head and shoulders. This type of pattern starts out looking like a classic head and shoulders reversal, but at some point in its development (either prior to the breaking of the neckline or just after it), prices resume their original trend.
There are two important lessons here. The first is that none of these chart patterns are infallible. They work most of the time, but not always. The second lesson is that technical traders must always be on the alert for chart signs that their analysis is incor­rect. One of the keys to survival in the financial markets is to keep trading losses small and to exit a losing trade as quickly as possi­ble. One of the greatest advantages of chart analysis is its abilityto quickly alert the trader to the fact that he or she is on the wrong side of the market. The ability and willingness to quickly recognize trading errors and to take defensive action immediately are qualities not to be taken lightly in the financial markets The Head And Shoulders as a Consolidation Pattern
Before moving on to the next price pattern, there's one final point to be made on the head and shoulders. We started this discussion by listing it as the best known and most reliable of the major reversal patterns. You should be warned, however, that this for­mation can, on occasion, act as a consolidation rather than a reversal pattern. When this does happen, it's the exception rather than the rule. We'll talk more about this in Chapter 6, "Con­tinuation Patterns."