Head and Shoulders
Definition
A head and shoulders pattern is a classic reversal formation with three peaks — a higher middle peak (the head) flanked by two lower peaks (the shoulders) — signaling the potential end of an uptrend.
Example
“The stock formed a textbook head and shoulders over two weeks. When it broke below the neckline at $44 on above-average volume, I entered short with a target at $38 and a stop above $45.20.”
Detailed Explanation
The pattern tells a story of a bull trend losing steam. The left shoulder forms as price rallies and pulls back. The head forms as price makes a new high — buyers still have some momentum. The right shoulder forms when the subsequent rally fails to reach the prior high, showing that sellers are increasingly willing to step in at lower and lower prices. The neckline connects the reaction lows between the peaks, and a break below it confirms the pattern.
Volume typically confirms the deterioration: the left shoulder forms on solid volume, the head on declining volume (the rally is becoming less convincing), and the right shoulder on even lighter volume. The breakdown through the neckline should come with a volume surge — sellers finally overwhelming the remaining buyers. If the neckline breaks on light volume, the pattern is less reliable and more prone to a fake breakdown followed by recovery.
The measured move target is calculated by taking the height from the neckline to the top of the head and subtracting it from the neckline breakdown point. On significant patterns — those forming on daily charts after extended uptrends — this can produce substantial short targets. Head and shoulders patterns on intraday charts are also valid but require adjusting your expectations for the magnitude of the move. Inverse head and shoulders (with the pattern flipped) signals bullish reversals using identical logic.