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The overall stock market formed a short-term peak in the latter part of October and declined until Black Friday, November 25. MYL made a low of $17.22 on November 22 (RS), which was just above the October 20 low of $17.02. This was also quite close to the August low. In a classic reverse head-and-shoulders bottom, the left and right shoulders are at approximately the same levels.

To complete a reverse head-and-shoulders bottom formation, MYL needs to close back above the neckline, ideally on good volume.

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The neckline was challenged in the early part of December, but it was not decisively broken on a closing basis until December 12. With this close, the reverse head-and-shoulders bottom formation was completed.

In order to determine the targets from a reverse head-and-shoulders formation, we take the distance from the low when the head was formed ($15.49) and subtract it from where the neckline was ($20.69) as MLY was making its low. This difference, ($20.69 - $15.49) $5.20, is then added to the breakout level of $20.22 to give you an approximate upside target of $25.42. This target can be then be used to measure the potential reward of the trade.

Once the neckline is broken on a closing basis, the strategy is to buy on a retest of the neckline or even a bit below it. In the case of MYL, it dropped as low as $19.88 before turning higher. The traditional place for a stop is under the RS low of $17.22. I would typically suggest using a stop that was 0.5% below this level, which would have been $17.04.

The risk of over $3 per share initially may have been too high for most, and I usually determine the stop on a case-by-case basis or just use an initial stop under the RS. Generally, once a reverse head-and-shoulders bottom is completed, it should move well above the neckline within the next week or so.  

Once the December 12 high at $20.65 was overcome, a stop under the prior low at $19.31 could have been used. If MYL dropped back below that low, it would suggest that the breakout was false.

In terms of managing this trade, I typically look at other factors in addition to the head-and-shoulders target to determine an exit level. The chart of MYL shows major trend line resistance, line a, in the $23.80 area. Therefore, selling half the position below this level—like between $23.52 and $23.68—would be prudent in order to lock in a good profit.

Additionally, when MYL moved above the $22 level, the open position would have had a near-9% gain, so a stop under $20.50 could have been used to lock in a small profit.

I find the on-balance volume (OBV) to be very helpful in identifying reverse H&S bottom formations, and the on-balance volume for MYL moved through the resistance at line b seven days before the neckline was broken.

NEXT: A Reverse H&S Bottom Nearing Completion