What is the head and shoulders pattern?

The parts of the pattern

• Left shoulder: a high within the uptrend, followed by a pullback.
• Head: a new high, above the left shoulder, followed by another pullback to a zone similar to the previous one.
• Right shoulder: another attempt to rise that falls short of the head. It’s the first objective sign of weakness: a lower high.
• Neckline: the line connecting the two lows between the shoulders and the head. It can be horizontal or slightly sloped.

The pattern isn’t confirmed until price closes below the neckline. Until then, it’s only a possibility.

How to calculate the target

Traders use the measured move rule: you measure the vertical distance between the head and the neckline, and project it downward from the breakdown point.

Example: in an example stock, the head reaches $60 and the neckline is at $52. The height is 60 − 52 = $8. If price closes below $52, the estimated target is 52 − 8 = $44.

That target is a reference, not a promise. Price can fall short or go further, and the target is mainly useful for comparing the potential move with the risk before you trade, that is, for estimating the risk/reward ratio.

Example of the inverse version

The inverse head and shoulders works the same way, but upside down. An example stock has been falling and makes a low at $33 (left shoulder), bounces to $36, drops to a new low of $30 (head), bounces back to $36, and makes one last low at $33.50 (right shoulder).

The neckline is at $36. The height of the pattern is 36 − 30 = $6. If price closes above $36, the estimated target is 36 + 6 = $42. Just as with the classic version, before that close there is only a possibility, and the invalidation point is usually placed below the right shoulder.

How it’s used in practice

• Volume: in the classic pattern, volume tends to be lighter on the right shoulder and to pick up on the break of the neckline.
• Retest: after the break, price often comes back to test the neckline from below. The old support zone starts acting as resistance.
• Inverse version: the inverse head and shoulders appears at the end of a decline, with the head as the lowest low, and is confirmed by a close above its neckline.

Common mistakes

Seeing the pattern too early is the main mistake: plenty of “almost formed” right shoulders end in a rally that clears the head. Another mistake is drawing the neckline wherever it suits you, moving it until it fits. And the third: forgetting it’s a reversal pattern, so it needs a clear prior trend to reverse.