Figure 1: Home Depot's head and shoulders pattern.
The first, and larger pattern, is a continuation head and shoulders pattern. Many traders think of head and shoulders patterns as reversals, but these can also signal a continuation of the prior trend, both up and down. The trend from January to June was clearly bullish and the consolidation marks a rest along the way. A break above neckline resistance at 35 would signal a continuation higher and project further strength to around 40, a level also confirmed by a 62% retracement of the mammoth decline from 52.6 to 20.4. (Note: The distance from the neckline to the bottom of the head is added to the neckline breakout for an upside projection (35 - 30 = 5, 35 + 5 = 40)).
|Figure 2: Home Depot showing a large symmetrical triangle.|
|Graphic provided by: MetaStock.|
|The second pattern is a symmetrical triangle that forms the right half of the head and shoulders. Since peaking at 35 on 18-Aug, Home Depot consolidated the last seven weeks. The stock formed a lower high in early September (blue arrow) and a higher low in mid September (black arrow). The consolidation continued to tighten into late September and then broke above the upper trendline with a big move in early October. Edwards and Magee refer to symmetrical triangles as coils that build up tension as they slowly tighten with the breakout acting as the catalyst.|
|The symmetrical triangle breakout is bullish, but the stock has yet to clear the bigger hurdle at 35 and October volume is not encouraging (red arrow). Volume is like fuel and plenty of it is required to sustain an advance. A breakout on high volume shows plenty of fuel and increases the chances of success. However, a low volume breakout reflects halfhearted buying interest and increases the chances of a failure. Even though the price action (symmetrical triangle breakout) is bullish, I would hold out for a neckline breakout at 35 on good volume before turning bullish again.|
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