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.
McKesson Corporation, together with its subsidiaries, delivers pharmaceuticals, medical supplies, and health care information technologies to the healthcare industry primarily in the United States. It operates in two segments, McKesson Distribution Solutions and McKesson Technology Solutions. The McKesson Distribution Solutions segment distributes ethical and proprietary drugs, medical-surgical supplies and equipment, and health and beauty care products in North America. This segment also provides specialty pharmaceutical solutions for biotech and pharmaceutical manufacturers. In addition, this segment sells financial, operational, and clinical solutions for retail, hospital, and alternate site pharmacies. The McKesson Technology Solutions segment delivers enterprise-wide clinical, patient care, financial, supply chain, and strategic management software solutions, as well as pharmacy automation solutions for hospitals. This segment also includes Payer group of businesses, which include InterQual clinical criteria solution, medical management tools, claims payment solutions, network performance tools, and care management programs.
To review the H&S pattern that has formed on McKesson’s stock, please take a look at the 1-year chart of MCK (McKesson Corporation) below with my added notations:
MCK has been rallying nicely since October of last year. Over the last (6) months though, MCK has created a very important level at $86 (navy), which would also be the “neckline” support for the H&S pattern. Above the neckline you will notice the H&S pattern itself (red). In order to confirm the H&S pattern, MCK would need to break the $86 support.
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 $86 support level. In short, whether you noticed the pattern or not, the trade would still be the same: On the break below the key $86 level.
The Tale of the Tape: After embarking on a 1-year uptrend, MCK has formed a Head & Shoulders pattern. A short trade should be entered on a break of the $86 support with a stop placed above the $86. Remember, there is no guarantee that MCK 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