Why is head & shoulder (H&S) important in technical analysis?

From a pure technical stand point, the forming of 3 peaks along with a proper neck-line simply points to the "distribution" or "topping" process that we commonly referred to.

Apart from the chart pattern itself, one vital important element in ascertain the validity of a H&S formation is the formation's time frame. If identified and used correctly, it is one of the most useful chart pattern in identifying major reversals.

What then constitute a valid H&S formation?

Simply put, empirical results show that a H&S formation spanning a multi-year period most likely is NOT a H&S formation at all. The reasoning is also quite simple as a typical topping process or distribution does not normally take such a long time to take shape. In order words, it does not make much sense for strong hands to use several years to sell into strength in anticipation of a major reversal!

Therefore, most if not all H&S formations are spanning towards a maximum of several weeks or months of time period. Indeed, one could also see powerful breakout in H&S formation in minutes, hourly or daily charts but not in those with multiple years of time frame.

Looking at HUI's chart, pattern (1) is clearly a H&S pattern in pictorial's sense. It would have been a complex H&S pattern with several heads & shoulders, i.e a rare form of H&S. However, once the time frame from 2002 to 2006 period is considered, the pattern is invalidated. In fact, prices rallied 183% from the neck-line of right shoulder from 2005 to 2008.

As where we are now, pattern (3) looks as perfectly a H&S as it can be. The multimillion question is, is this a valid H&S after all?

Again, considering the time frame spanning from 2009 to 2013, the chances are that it will be INVALIDATED sooner if not later. Conversely, if it were to be a valid one, the minimum textbook draw-down (highlighted red bar) will break the multi-year uptrend support line from 2000 through 2008 for good! This would spell dealth and doom on both miners' and gold's rally.

The only valid H&S pattern as we can see on hindsight is really pattern (2) when all risky assets were at their euphoric state back in 2007 - 2008 period. Such was the fundamental backing needed to see a breakdown in a major H&S pattern.

In conclusion, I would certainly advise cautious on bear & bull wannabes in identifying and utilizing a valid H&S formation.

As in miners' case, it does look to me that it is NOT a valid one especially given the fact that gold price itself (See: http://tinyurl.com/at2dvac) is depicting a highly probable reversed H&S pattern from 2012, i.e in about a year period.

The technical consideration for a reversed H&S pattern is somewhat different to that of a H&S' and i shall talk about it another time.