Head and Shoulders Charting Tutorial – SJ Options
SJOptions.com presents a tutorial on Head and Shoulders and charting. Learn to draw support and resistance lines and how to recognize this chart pattern. There is a formation right now, and if we break support, we could see a 12 to 15% drop in the markets. It's a good time to use positive Vomma with options to be safe and profitable for this next down turn.
Visit SJOptions.com and learn how to trade the Second Order Greeks to get an edge on your competition! Stop thinkingl Just visit us now.
Hi there everybody! Welcome back to class. In this demonstration, we’ll be talking about the head and shoulders pattern. We have a live head and shoulders going right now on the Russell so we’ll look at that and we’ll do some forecasting. The head and shoulders is, again, one of the most common patterns that you’ll see for—that’ll indicate reversals. A lot of option traders or stock traders recognize this pattern and, again, it’s a psychological thing where everybody sees it and then they make it happen because they all read charts in the same way. It’s important that you understand how to recognize this because it’s a very good forecasting tool for reversals.
If we come over here, you’ll see stockcharts.com and again if you want to further your education for free on patterns, this site has all kinds of information. Here you can see head and shoulders, it’s upside down, it’s at the bottom but you can see the formation here, what it looks like. So you’ll be usually in a trend going one direction for a while and it’ll come to a point where it starts to go sideways. So it starts to form a sideways channel when you’re either going up or down for a long time. You’ll have this higher point which they call the head. So you’ll have—you’ll usually form. You’ll be coming down through a channel, it’ll start going sideways and it’ll form a left shoulder and then a higher point or a lower point in this case and then another shoulder. And then it breaks out of the patter, that sideways pattern, going the other direction. What you do is you measure this distance from the head to this base and that’s the forecasted that would go the other way. Let me see if I can find some other pictures.
Here’s another one at the bottom and they drew it a little differently but you see how it’s, in this channel, coming down and then right here, it’s no longer in the downward channel ‘cause it’s breaking out right in this point. So it starts to go sideways from there and then it—in this point here it starts to breakout the other direction. Here’s another and I guess those are all the—let me see if I could find one on the top side. Here’s the top side pattern and this is what we’re looking at today in the market. you have this situation where the trend is going up and then all of a sudden it starts to make lower lows so it breaks through this support and then it comes down and then it forms a new base and it starts that sideways pattern. So the high up here is the head which would be kind of the last high in that upper channel. When it comes down, breaks this support line then it stops somewhere in here and makes another, a new support, where it starts to go sideways. So you have this sideways pattern forming, you can see. It stats that channel and then this base down here eventually breaks and then you measure this distance here that head to the base and that would be the forecasted amount that it goes down.
Let’s look for some other examples. Here you can see where they’re explaining this. So you have 3 points and then the predicted move is that far after it happens. Let’s look at a real example. Right now in the market we have the Russell and it had this long upward trend and we can see how the trend stopped right in this zone. So you have where it’s coming up here at its channel and right here made its highest high and it didn’t really go up any higher after that. it just sort of came down and finally broke this support. Once it breaks the support now it’s starting this other trend the different direction. Now we’re in the sideways part and then after this we’re noticing that we had a higher area here that we consider the head and then you have this zone over here, we could consider this whole part to be a shoulder and then over here forming another shoulder and then you have the base down here that we’re watching to see if it gets broken. And so if we fall through this, then we’re looking at measuring this channel here and then forecasting a similar move to the downside which would be somewhere in this zone, 700-725 will be about the forecasted drop. So currently the Russell’s almost 800 and so if we do break these, then we’re looking for a possible pretty quick 100-point drop in that. And then when we combine this with other support resistance, it helps us identify where it could fall also and you see through here there’s not much but right in here, it almost looks like there’s another head and shoulders that formed in the bottom side and then it broke out, broke out that way. But anyway you can come through and draw. And see here’s an actual support line because it lines up with all these tops through here, you see in the bottom here and that corresponds with that distance. The measurement here basically is like the channel right there and then it breaks and forms another similar channel. So anyway it looks like this is—that’s about where the market would go initially with that breakthrough if this head and shoulders forms and completes the formation.
And you could see one over here as well. So in here it looks like it’s going up a little bit but you have this lower point here, you have this other base in here. Let me delete all this. So you have, again, this kind of channel right here and this head there. So it kind of goes through and then right in here, you know, is that breakout. And then it makes its move up and it’s forming this other channel at that point. This could be sort of a longer term one in there that had a breakout and one up here that’s forming another one. So you could kind of see that.
Anyway, just a tutorial there in head and shoulders and how to recognize them and prepare your portfolio for them and so, again when we see this happening and we combine things with the Macd to help us better forecast what might happen. But if you see this formation, then again, with your trade you can make sure they have the positive vega and positive vama so if the market crashes volatility will go up with these equity markets and then you’ll be prepared ‘cause you’ll have the positive vama built in to your trades and you can profit from that and be hedged before it ever happens. The charts patterns are—it’s necessary to understand them. I mean, obviously we’re not always right but we want to prepare the portfolio just in case they do come to fruition. Again, that’s what we’re seeing now, just we have time to which is nice. They don’t usually form in a week or two, these usually take a few months so it does give us time to position our vama in the correct way and actually take advantage of what could happen with volatility.
If we move over to the volatility on this, we can see if it has any similar patterns also. And it almost looks like it’s forming the upside down, again, you kind of have through here, this lower. So you can see the shoulder’s building in here and then the head coming out to down here. We’re seeing this possible in other formation. So you have a head right there and you have shoulders over here and over here, see. So you got two shoulders, head and then we’re waiting for it to break this. So this is a really key level, a 27.5 level on the RVX if we break through that. especially if it’s combined with the Macd starting to move higher, like let’s say, it moves up over here compared to these lower moves. So if we see some of this acceleration and conviction on the Macd combined with the breakout of this line, then that’s a pretty strong sign that we could have a move up in the volatility and then you will be looking at measuring this which goes from about 19-27, so almost a 10-point move beyond this. So it’d be about to 38 which would bring that breakout initially going almost up to the 40-level. And with volatility, it kind of snowballs so you could see for example over here, what have that breakout and it just went way up. So this could be underestimating the move of volatility, just moving to here. It could spike up higher and kind of come down to that zone. But we’re seeing this head and shoulders formation on both the volatility and the price so it’s definitely a heads up and time to take advantage and make sure you build those positive vama trades.
Okay, well, that’s it. Just want to talk about head and shoulder patterns and we’ll end this tutorial. Thank you very much and have a great day!