I’m getting a lot of questions about fake head and shoulders patterns on Facebook. I’m putting the answer up as a post because Facebook presents a good example right now of real vs. fake head and shoulders patterns.
A Real Head and Shoulders and a Fake One on the Facebook Chart
The small head and shoulders that formed earlier this year (pink neckline on chart) was a real head and shoulders. It was a classic, clean formation that broke out downwards through the neckline.
But it was much too small to be the top of the move up from June 2013. It is almost certainly the top of the left shoulder of a larger head and shoulders, or the beginning of a larger megaphone pattern (see scenarios on chart). The larger head and shoulders or megaphone pattern should form roughly as shown in the chart, and can break out in either direction.
The Larger Facebook Head and Shoulders is Likely a Fake
But the potential Facebook head and shoulders with the red neckline (chart below) is almost certainly a fake.
One major tell that it is a fake is that it started spinning a megaphone for a right shoulder. On a real head and shoulders that is going to break out downwards, the right shoulder should be fast, small and panicky. It represents big money scrambling to get out.
A megaphone represents either a major battle, with conviction on both sides (something you shouldn’t be seeing in a real right shoulder) or a move that’s run out of energy (another thing you shouldn’t be seeing in a real right shoulder). When you see a right shoulder start forming a megaphone, the price is almost certainly going to a new high. That new high will be the head of the real head and shoulders pattern.
I’ve drawn a blue horizontal line in roughly the middle of that megaphone right shoulder. That line is the VWAP (volume weighted average price) for that megaphone. After Facebook picks a top for the current price move up, it will dip to at least that VWAP level before heading up to and probably through the megaphone top to put in the new high for the larger head and shoulders.
Facebook could also head one more time to the blue megaphone bottom. That would take the price through the red neckline in a fake breakout.
The price must return to the blue megaphone VWAP after that fake breakout, if it occurs. If the price then reverses at VWAP and breaks out downwards through the blue megaphone bottom (NOT the red neckline), only then will the downward breakout be real.
But that’s unlikely. Most likely FB will dip to the blue megaphone VWAP and then head up to a new high.
Even Real Head and Shoulders Patterns Can Break Out Upwards
One thing to keep in mind is that even after that new high, and after the larger head and shoulders or megaphone forms, it can break out in either direction. A head and shoulders can be a topping pattern, but it can also be a continuation pattern. And if the price continues upwards out of the H&S, the move will be explosive.
If a real head and shoulders pattern is going to break out upwards, it will usually fail in the area where the right shoulder top should be. That’s because head and shoulders patterns are also usually megaphones, and that right shoulder top would usually form at the megaphone VWAP. When a price breaks out upwards through a megaphone VWAP, it is usually committing to a trip to the megaphone top.
The way a right shoulder failure usually plays out is with a consolidation (often a small megaphone) at the area where the right shoulder top would be. Sometimes the consolidation is a violent struggle, with big swings in both directions. Other times it is a very small and tight consolidation. Either way, if that consolidation breaks out the top, you want to bet with that breakout.