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Validity of Head and Shoulder Pattern - as illustrated by Miners (HUI)

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

  2. 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.

  3. 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.

  4. What then constitute a valid H&S formation?

  5. 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!

  6. 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.

  7. 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.

  8. Larger Image

  9. 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?

  10. 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.

  11. 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.

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

  13. 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.

  14. 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.


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