The pattern has a neckline. This is created by connecting the lows of the left and right shoulders. In addition to providing a leading indicator of a significant trend change, the pattern is also used to established the downside targets. The distance between the neckline and the 'head' is measured. This value is projected downwards to set the downside target. These downside targets may appear extreme, but they are often very accurate.
For example, the head and shoulder pattern in the NASDAQ achieved its downside targets at the end of January. The downside targets are most reliable when they are also equal to previously established support levels, such as 2,200 with NASDAQ.
This pattern analysis suggests caution with BHP ADR for those expecting a much higher upside when the current takeover is fully played out. However, the analysis is also applied with caution because the head and shoulder pattern is being retested.
Head, Shoulders, BHP
This is the activity required to validate, or prove, the pattern:
- A continued retreat from the neckline which is now acting as a resistance barrier.
- A retreat from the $74.00 area on a weekly chart.
- A fall below $64.00.
When these features develop, we would expect to see a continuation of the downtrend with targets in the $37.00 range. The $37.00 level is a well established support level.
This is the activity required to invalidate the pattern and show a continuation of the long term uptrend:
- A sustained close above $74.00 on a weekly chart.
- A move above the neckline.
- Trend strength is confirmed when the neckline is used as a support level for any suggested price retreat.
- A retreat to the neckline followed by a price rebound. Price must move above the peak of the right shoulder near $79.00 before the head and shoulder pattern is completely invalidated.
Under these conditions the upside for BHP ADR is established initially near $87.00. Traders will watch for a appropriate method of trend definition to determine highs above this initial target.
Although the head shoulder pattern is used to set downside targets, it does not provide a useful method of setting upside targets when the chart pattern is invalidated.
This is a developing pattern and it may be several weeks away from either confirmation or invalidation. The chart pattern signals bear side caution. The developing pattern is seen on both the BHP ADR and the BHP Australia charts.
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