Monday, March 22, 2010

Head and Shoulders in Gold

One of the most recognizable technical patterns is the head shoulders pattern. This is a pattern that is classified as a reversal pattern because its completion usually means a new trend has started. The pattern starts with a rise in price, followed by a sell-off period that retraces some of the gains. Then there’s a second rally that takes the price to a higher peak, and another sell-off period that falls to roughly the same level as the previous sell-off. Finally, there’s a third, weaker rally that forms a lower peak, and a sell-off that breaks below the low price of the previous two selling periods.

The chart below is a price chart of the June 2010 future contract for gold from 2/1/10 to 3/22/10. The first rise in price, or the left shoulder, peaks at $1,123/oz, as indicated by the first red arrow. The second rise in price, or the head, peaks at $1,144, as indicated by the green arrow. The last rise in price, or the right shoulder, peaks at $1,128, as indicated by the second red arrow. The white line is called the neckline, and if prices break below this line a sell signal is generated.

Furthermore, downside targets can be projected by taking the difference between the head peak and the neckline, and subtracting that number from the neckline. Specifically with gold, the peak is $1,144 and the neckline is $1,100, which would project a decline to at least $1,050, but the closely-watched level of $1,000 could also be reached.