Phillips 66 (NYSE: PSX)

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. A break of the support would be the confirmation of the pattern.
To review a current H&S pattern, please take a look at the 1-year chart of PSX (Phillips 66) below with my added notations:
PSX had been on a year-long rally since its bottom in June. Over the last (3) months the stock has created a very important level at $60 (blue), which was also the “neckline” support for the H&S pattern. Above the neckline you will notice the H&S pattern itself (red). Confirmation of the H&S occurred when PSX broke its $60 “neckline” support. So, the stock should be moving lower overall from here.
Keep in mind that simple is usually better. Had I never pointed out this H&S pattern, one would still think this stock is moving lower simply if it broke below the $60 support level. In short, whether you noticed the pattern or not, the trade would still be the same: On the break below the key $60 level.
The Tale of the Tape: After embarking on a nice uptrend, PSX confirmed a head & shoulders pattern. A short trade could be placed now, or could be entered on any rallies up to or near the $60 level.
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