RGR (Head and Shoulder Formation, SHS, Shoulder-Head-Shoulder)

What is an RGR, or head and shoulders formation?

RGR is one of the most popular price formations. It is formed both at the end of an upward and downward trend. Its characteristic feature is a specific alignment – peaks and bottoms.

In this formation, the head is the highest point, while the left and right shoulders form at a very similar price level. Any deviation to one side or the other will cause the formation to be missed by the market.

The so-called neck line, on the other hand, is the level that connects the pits following before and after the formation of the head. This line is, at best, a horizontal line – but it does not contain such restrictive conditions. It usually happens that it is inclined upward. It is less common for it to slope downward.

 

How to determine the height of the formation and its value?

The height of the formation is determined as the distance between the head and the neckline. This is the value that is used to construct the range of the formation.

When it comes to the stock or futures market, where the volume or number of open positions is usually given, it is worth remembering to look for confirmation in the data. The following peaks of the formation (left shoulder, head, right shoulder) should be formed with lower and lower volumes. In turn, the breakout from the neckline is very often associated with confirmation of a significant increase in volume.

How to use the head and shoulders formation? Psychological outline

The high effectiveness of this formation is largely due to its construction. It is worth noting that the upward trend continues as long as successive peaks and bottoms are formed at higher and higher levels.

In the case of the RGR, the right shoulder is the peak located below the previous one. This shape causes a lot of uncertainty in the markets and, as a result, waiting for the next move to be made.

If the downtrend is reversed then very often it is enough to abandon taking further long positions for the reversal to become a reality.

RGR – what to keep in mind

This is the greatest strength of this formation – the hesitation of the bulls allows to create space for the activity of the selling side.

It is worth remembering that the neck line defines a critical level, which is support for the entire upward movement. When the line is pierced, it conveys signals that give the signal to close this position. In turn, the test gives a signal to open short positions.

How to use RGR in the stock market?

In theory, traders suggest selling when there is a test of the neckline from below. Then – after the breakout – the market returns, and if eventually the next peak is the height of the neckline or lower then the formation is fully formed.

The projection of the movement is determined after the breakthrough of the neck line, by measuring the height of the formation from the point of breakthrough.

Usually this is a target level, but this does not mean that the market will stop at that point, or reach that level. It is worth keeping this in mind.

How else can we measure coverage?

First of all, using Fibonacci ratios. The height of the Head and Shoulders formation is then treated as the value of 1. Then the minimum range of the formation is defined as 0.618 height. The next levels, in turn, are 1, 1.618, 2.618.

For a value of 100 points, the moment the neckline is pierced sets target levels 62 points, 100 points, 162 points and 262 points away.

Preservation of trading volume – a key aspect

One of the most important factors shaping the price structure is the behavior of trading volume.

What is worth keeping in mind?

• A price drop below the neckline should take place on increased trading volume. This will indicate very aggressive supply, which efficiently meets demand at ever lower price levels.
• The amount of rotation when shaping the head should be smaller than it is when shaping the left arm.
• The right arm should be shaped on an even lower rotation volume.
• The return of the price to the neckline should take place at significantly lower turnover.