A Head and Shoulders (H&S) pattern is a reversal pattern that forms after an uptrend. A textbook H&S pattern starts to form when a stock rallies to a point and then pulls back to a particular level (shoulder #1). Next, the stock will rally again, but this time to a higher peak (head) than the previous shoulder. After forming the head, the stock will pull back to the same support as the first shoulder did. Finally, the stock rallies a 3rd time, but not as high as the head (shoulder #2). The level that has been created by all 3 of the pullbacks is simply a support level referred to as the “neckline”. The formation of an H&S pattern warns of a potential reversal of the uptrend into a possible downtrend.
Canadian Pacific Railway Limited has 14,700-mile network serving the principal business centers of Canada, from Montreal to Vancouver, British Columbia and the United States Midwest and Northeast regions. Its network is consisted of four primary corridors: Western, Eastern, Central and the Northeast United States. The Western Corridor links Vancouver with Thunder Bay, Ontario, which is the western Canadian terminus of its Eastern corridor. The Western Corridor provides access to the Port of Thunder Bay, Canada’s Great Lakes bulk terminal. Its business includes bulk, which include grain, coal, and sulphur and fertilizer; merchandise, which include forest products, industrial and consumer products, and automotive; and intermodal.
To review the H&S pattern that has formed on Canadian Pacific’s stock, please take a look at the 1-year chart of CP (Canadian Pacific Railway Limited) below with my added notations:
CP has been on a 6-month rally since September of last year. Over the last (3) months, CP has created a very important level at $72 (black), which would also be the “neckline” support for the H&S pattern. Above the neckline you will notice the H&S pattern itself (blue). In order to confirm the H&S pattern, CP would need to break the $72 support, in which case, the stock should be moving overall lower from there.
Keep in mind that simple is usually better. Had I never pointed out this H&S pattern, one would still think this stock is moving lower simply if it broke below the $72 support level. In short, whether you noticed the pattern or not, the trade would still be the same: On the break below the key $72 level.
The Tale of the Tape: After embarking on a 6-month uptrend, CP has formed a Head & Shoulders pattern. A short trade should be entered on a break of the $72 support with a stop placed above the $72. Remember, there is no guarantee that CP will break lower.
Before making any trading decision, decide which side of the trade you believe gives you the highest probability of success. Do you prefer the short side of the market, long side, or do you want to be in the market at all? If you haven’t thought about it, review the overall indices themselves. For example, take a look at the S&P 500. Is it trending higher or lower? Has it recently broken through a key resistance or support level? Making these decisions ahead of time will help you decide which side of the trade you believe gives you the best opportunities.
No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade. Capital preservation is always key!
Christian Tharp, CMT