Dangerous Preoccupation

May 11, 2001
Eddie Kwong

It is always fun and
exciting to learn new charting techniques. I still remember the day
when I discovered a head-and-shoulders pattern. I thought I had gained the best
tool for success. Immediately the following trading day, my quest for head-and-shoulders
patterns began. If I think about it now, I was really forcing myself to see the
pattern where nothing was actually developing. Because I was so obsessed with
one idea, I failed to recognize anything else on a chart. You have to really
observe what is developing in front of your eyes. Pattern recognition is not a
make-believe game. Preoccupation with only one pattern can be dangerous and
costly to your trading. Let me show you an example.Â

The chart below is the daily chart of JC Penney (JCP).
It looks like the stock was forming a head-and-shoulders pattern, as you can
see. Was it just a case of a head-and-shoulders failure, or was it something
else? I remember a few traders were talking in a chat room about shorting the
issue as soon as the neckline was violated. In fact, it happened on April 4. JC
Penney even traded below its 50-day moving average in addition to a violation of
its neckline. But, the stock began to reverse strongly the following trading
session. What went wrong?

Actually, we should not consider this pattern a head and shoulders. Why? Focus
on heavy, healthy volume when the head was forming. If it were a head-and-shoulders
pattern, we had to see decreasing volume when the head was shaping.