It is one of the most well-known chartist analysis figures, if not the most. It is a fairly classic figure, and it achieved sad notoriety due to the fact that the Wall Street crash of 1929 drew a “perfect” shoulder-head-shoulder structure, as can be seen in the following graph:
The HCH figure is used to anticipate a change in trend from bullish to bearish, which is usually true in approximately 70% of cases, which gives this figure a lot of reliability.
Graphically, it consists of a central bull run (the “head”), preceded by a previous bull run with a lower high (“left shoulder”), and followed by a subsequent bull run with a lower high (“right shoulder”). A trend line, called the neckline or clavicle line, joins the lows of the figure:
The HCH figure is formed following the following guidelines:
1) The previous trend is up
2) Left shoulder: It enters upwards on the left shoulder. The rise is accompanied by a large volume, until reaching the peak of the left shoulder. In the subsequent drop, a lower trading volume can be seen
3) Head: As soon as the prices “touch” the clavicular line, a more pronounced upward reaction than the previous one takes place, which takes the prices to their maximum (the peak of the head) In turn, in the upward phase of the head raises the volume again, although to a lesser extent than in the rise of the left shoulder. Subsequently, prices fall back to the collarbone line. This bearish phase of the head also entails lower trading volume.
4) Right shoulder: It is formed during the third upward movement. Usually the right shoulder is lower (asymmetrical) than the left, and of course it is lower than the head. The trading volume is significantly lower than the trading volume of the previous bullish phases.
At this moment the warning of the formation of the figure appears, showing in this reaction a strange and abnormal appreciable reduction in volume, which continues when the movement changes and reacts downwards. Volume is very high on the left shoulder, only high on the bullish head phase, and low on the entire right shoulder phase.
Pay attention to the clavicle line at this point, as its orientation can offer additional confirmation of the trend reversal:
– If the clavicle line is tilted upwards, it is usually a symptom that despite everything, the inertia of the upward movement prior to the HCH figure will remain
– If the line is horizontal or inclined downwards, it usually indicates a reinforcement of the expected change in trend.
The moment the price breaks the collarbone line by more than 3-5% we would have a confirmation of the change in trend. Volume analysis is important, as the higher the volume on the breakout move down from the collarbone, the more likely the trend reversal will be.
Although the explanation of the formation of the figure may seem easy, in reality it is not so easy to identify, since sometimes it presents complex figures that are difficult to interpret, especially the creation of numerous shoulders to the left and to the right of the figure. the head, resulting in a longer period of lateral movement than the traditional HCH figure.
The formation time of the figure can vary between 2-4 weeks to even years. The longer the formation period, the more virulent and longer the subsequent bearish phase will be. The magnitude of the rupture is subject to a series of specific circumstances.
– The movement of the output will be proportional to the movement prior to the figure.
– The intensity and magnitude of the exit movement depends on the width of the model or the length of the clavicle line and the perfection of the figure. When the figure deforms (because it is too wide), it is no longer an HCH but another type of longer-term figures.
– The minimum price at which the exit movement will arrive is obtained by projecting the vertical distance from the peak of the head to the collarbone line (example, if the collarbone line is at 7 euros/share and the peak of the head is at 10 euros a share, the minimum expected price after the breakout would be 4 euros a share)
Optimal investment decisions will obviously be to try to sell either at the top of the left shoulder or (best case scenario) at the top of the head. There is one last chance at the top of the right shoulder, but because the volume is so much lower, an institutional investor could find it difficult to dump the stock due to lower demand.
Finally, it should be noted that there is also the figure that describes the reverse phenomenon, which is that of the inverted HCH, in which it indicates a change from bearish to bullish trend. Everything described above applies, although the bullish and bearish phases described are obviously contrary.