The idea
A head and shoulders top has three peaks: a left shoulder, a higher head and a right shoulder at about the height of the left one. The lows between them form the neckline. A close below the neckline completes the pattern and is the sell signal.
The target is the distance from the head to the neckline, measured down from the neckline. The inverse head and shoulders is the same pattern upside down at the end of a decline.
Watch it play out
Step by step
The rules
Setup
- A left shoulder, a higher head, and a right shoulder near the left one's height.
- A neckline through the lows between them.
Entry
- Sell short on a close below the neckline.
Stop-loss
- Above the right shoulder.
Target
- The head's height above the neckline, measured down from it.
Filters that help
- Prefer it after a long uptrend.
- Volume falling into the right shoulder is a common confirmation.
Why it can work
The right shoulder failing to reach the head's height shows the buyers weakening. When the neckline breaks, the higher lows that kept the uptrend alive are gone, and the trend has changed character.
The neckline is where buyers defended the uptrend twice. Once it breaks, traders who bought those dips are losing, and their sell-stops under the neckline add to the fall. That is why a decisive close below it matters more than the shape of the peaks.
Worked example
A stock makes peaks at $96.50, $99.60 and $96.40, with lows near $92.75 between them. It closes at $92.30, below the neckline: sell short, with the stop above the right shoulder at $96.60.
The head stands $6.85 above the neckline, so the target is $85.90. Risking $100, the $4.30 stop allows 23 shares.
When it works, when it fails
Works best
At the end of long uptrends, on higher timeframes, with a clean neckline break.
Struggles
When the break reverses back above the neckline, a common trap, and when traders see the pattern everywhere. A stop above the right shoulder is often wide.
Common mistakes
- Shorting the right shoulder before the neckline breaks.
- Drawing a neckline that bends to fit.
- Ignoring a strong overall uptrend that keeps going.
Variations
- Neckline retest entry
- Waiting for price to come back up to the broken neckline and fail there before shorting, which gives a closer stop and fewer false breaks.
- Inverse head and shoulders
- The bullish version at a low: three troughs, the middle deepest, bought on a close above the neckline.
What the evidence says
Evidence: Tested, mixedPublic tests disagree, or the edge has faded over time.
In the same study of US stocks from 1962 to 1996, head and shoulders was among the patterns found to carry some information about subsequent returns.
That falls short of showing a profitable rule after costs. Hence mixed: one of the most studied chart patterns, with evidence that it means something, not that trading it pays.
Questions
- What is an inverse head and shoulders?
- The bullish mirror image at the end of a decline: three troughs with the middle one deepest. A close above the neckline is the buy, with the target the head's depth projected up.
- What if price returns above the neckline after the break?
- That is a failed pattern, a common trap. Many traders close the short at once when price closes back above the neckline rather than waiting for the stop above the right shoulder.
- Is head and shoulders bullish or bearish?
- The normal pattern at a top is bearish. The inverse version at a bottom is bullish.
- How do I draw the neckline?
- Through the two lows between the shoulders and the head. It can slope, but it should touch both lows without bending.
- What is the head and shoulders target?
- The height from the head to the neckline, projected from the break. Like any pattern target, it is a guide.