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.
Medivation, Inc., a biopharmaceutical company, focuses on developing novel small molecule drugs for the treatment of serious diseases in the United States and Europe. The companys lead development candidate includes MDV3100, a molecule, which is in Phase-III development for the treatment of castration-resistant prostate cancer. Medivation, Inc. has collaboration with Astellas for the development, manufacture, and commercialization of MDV3100 for the treatment of prostate cancer. The company was founded in 2003 and is headquartered in San Francisco, California.
To review the H&S pattern that has formed on Medivation’s stock, please take a look at the 1-year chart of MDVN (MEdivation, Inc.) below with my added notations:
MDVN has been trending higher for the whole year. Over the last (2) months though, the stock has created a key price level at $50 (red), which would also be the “neckline” support for the H&S pattern. Above the neckline you will notice the H&S pattern itself (blue). Confirmation of the H&S would occur if MDVN broke its $50 “neckline” support. If that happens, the stock should be moving 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 $50 support level. In short, whether you noticed the pattern or not, the trade would still be the same: On the break below the key $50 level.
The Tale of the Tape: After embarking on a year long uptrend, MDVN formed a Head & Shoulders pattern. Although the $50 support may hold for long trades, the pattern implies an impending break lower. A break of the $50 “neckline” would present an opportunity for a short trade.
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