Arrow Electronics, Inc. (NYSE: ARW)

It is nearly impossible to talk about chart patterns on stocks without eventually discussing the very common head and shoulders (H&S) pattern. An H&S pattern is a reversal pattern that forms after an uptrend. A textbook H&S pattern starts to form when a stock rallies to a point and then pulls back to a particular level (shoulder #1). Next, the stock will rally again, but this time to a higher peak (head) than the previous shoulder. After forming the head, the stock will pull back to the same support as the first shoulder did. Finally, the stock rallies a 3rd time, but not as high as the head (shoulder #2). The level that has been created by all 3 of the pullbacks is simply a support level referred to as the "neckline". The formation of an H&S pattern warns of a potential reversal of the uptrend into a possible downtrend.

As with any chart pattern, a trader will usually not want to act on the pattern until the stock "confirms" the pattern. Confirmation is the break of the key level that has been created by the pattern. In the case of an H&S, confirmation would be when the stock breaks the neckline (support).

What some new traders do not know is that H&S patterns can also form upside-down after an uptrend as well. This pattern is a little more rare and would be called an inverse head and shoulders pattern. It would also be considered a continuation pattern, not a reversal pattern, and the neckline would be a resistance rather than a support. To see such a pattern formed, please take a look at the 1-year chart of ARW (Arrow Electronics, Inc.) below with my added notations:

Although one cannot really consider ARW's rally from July to August and uptrend, the stock had moved over 20% higher when the stock formed what appeared to be an inverse H&S (blue). I have noted the head (H) and the shoulders (S) to make the pattern more visible. ARW's neckline was at the $38 level (red). ARW confirmed the pattern by breaking up through the $38 resistance/neckline earlier this week and the stock should be moving higher from here.

Lastly, keep in mind that simple is usually better. Had I never pointed out this inverse H&S pattern, one would still think this stock is moving higher simply because it broke through the $38 resistance level. In short, whether you noticed the pattern or not, the trade would still be the same: On the break above the key $38 level