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 (left shoulder). Next, the stock will rally again, but this time to a higher peak (head) than the previous one. After forming the head, the stock will pull back to the same support that the first shoulder did. Finally, the stock rallies a 3rd time, but not as high as the head (right shoulder). 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.
Apple, Inc., together with subsidiaries, designs, manufactures, and markets mobile communication and media devices, personal computers, and portable digital music players; and sells related software, services, peripherals, networking solutions, and third-party digital content and applications worldwide. Its products and services include iPhone, iPad, Mac, iPod, Apple TV, the iOS and Mac OS X operating systems, iCloud, and various accessory and support offerings, as well as a range of consumer and professional software applications. The company sells its products and services to consumers, small and mid-sized business, education, enterprise, and government customers through its retail stores, online stores, and direct sales force, as well as through third-party cellular network carriers, wholesalers, retailers, and value-added resellers. In addition, it offers various third-party iPhone, iPad, Mac, and iPod compatible products, including application software, printers, storage devices, speakers, headphones, and other accessories and peripherals, through its online and retail stores; and digital content and applications through the iTunes Store, App Store, iBookstore, and Mac App Store.
To review the H&S pattern that has formed on Apple’s stock, please take a look at the 1-year chart of AAPL (Apple, Inc.) below with my added notations:
AAPL has been on a 4-month rally since its April-May correction. Over the last (2) months, AAPL has created a very important level at $650 (blue), which would also be the “neckline” support for the H&S pattern. Above the neckline you will notice the H&S pattern itself (red). Confirmation of the H&S occurred when AAPL broke its $650 “neckline” support. The stock should be moving lower from here.
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 $650 support level. In short, whether you noticed the pattern or not, the trade would still be the same: On the break below the key $650 level.
The Tale of the Tape: After embarking on a 4-month uptrend, AAPL confirmed a Head & Shoulders pattern. A short trade should be entered on any rallies up to or near the $650 level.
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