Merck & Co, Inc (NYSE:MRK)

A head and shoulders (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 (left shoulder). Next, the stock will rally again, but this time to a higher peak (head) than the previous one. After forming the head, the stock will pull back to the same support area that the first shoulder did. Finally, the stock rallies a 3rd time, but not as high as the head (right shoulder). 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.

To review the H&S pattern that has formed on Merck & Company’s stock, please take a look at the 1-year chart of MRK (Merck & Company, Inc.) below with my added notations:

 

MRK had been on a 5-month rally since its bottom in June. Over the last (6) months, the stock has created a very important level at $42.50 (red), which would also be the “neckline” support for the H&S pattern. Above the neckline you will notice the H&S pattern itself (blue). Confirmation of the H&S occurred when MRK broke its $42.50 “neckline” support. Also, notice the volume spike on the breakdown (pink). Volume increases on breakouts or breakdowns add validity to the break. So, the stock should be moving lower overall from here.