The secret weapon behind stock price reversals: Understand the head and shoulders top and bottom in one go

In the stock market, technical analysis is like reading a person’s face—patterns can reveal the underlying details. Among them, the classic formations of Head and Shoulders Top and Head and Shoulders Bottom can help investors grasp key entry and exit points.

But to truly master these patterns, you first need to understand a core concept: What is the neckline? Simply put, the neckline is the line connecting the lows of each wave, and it plays different roles at different stages—sometimes as support, sometimes as resistance.

Head and Shoulders Top: Recognizing the “High Not Surpassing the Previous High” Warning Signal

What does a Head and Shoulders Top represent? It shows that the stock price has formed three relatively high points (left shoulder, head, right shoulder), but the right shoulder cannot surpass the head, indicating a gradually weakening trend.

Psychological perspective on the formation of the Head and Shoulders Top

Left shoulder stage: The price rises in the first wave. Some take profits, while others remain optimistic about the future, leading to a tug-of-war between buyers and sellers. The price briefly pulls back, and this low point is the neckline—an important support level.

Head stage: After a shakeout, a new wave of buyers pushes the price to a new high. But as the height increases, new buying interest diminishes, and selling pressure begins to grow, forming the head and reversing downward.

Right shoulder stage: When the price falls back near the neckline, some traders who entered at the lows start to rebound, attempting to lift the price. However, this rally ultimately fails to break previous highs, completing the third shoulder. At this point, the neckline shifts from support to resistance.

Practical entry signals

• When the price breaks below the neckline, consider selling immediately—this is the clearest danger signal.
• If the price rebounds above the neckline, observe whether a new pattern forms; otherwise, consider exiting.

Three profit-taking points for short positions

For short sellers, the Head and Shoulders Top is an excellent opportunity, but three defensive lines should be set:

1. Entry point: When the price breaks below the neckline.
2. Exit point: When the price re-breaks above the neckline—close the position immediately (regardless of profit).
3. Target point: Use the distance from the entry price to the head as the target; once reached, exit.

Tencent case: In January 2023, a head formed, the right shoulder completed in March, and the neckline was broken around 360 yuan in April—if shorted then with a target of 305, the goal could be achieved in just one month. Many traders did not follow discipline, waited half a year, and ultimately gained limited benefits.

Head and Shoulders Bottom: A Signal of Trend Reversal and Rising

The Head and Shoulders Bottom is the mirror image of the Top, indicating that selling pressure is gradually weakening, and new buying interest is continuously entering.

The three-stage logic of bottoming

Left shoulder: A rebound during a downtrend, with many bottom-fishers entering to push the price higher. Due to insufficient upward momentum, the price eventually falls back. Trading volume is usually larger.

Head: The lowest point of the decline. Volume is minimal at this stage because sellers have mostly exited, and buyers are not eager to enter. Small buy orders can lift the price.

Right shoulder: The lows start to rise gradually, indicating that buy orders for support are entering. Whether it’s stop-loss covering or new buyers stepping in, both weaken selling pressure and strengthen upward momentum.

Two entry signals

• Enter when the right shoulder forms: At this point, the trend features “not lower than the previous low, higher than the previous high,” with higher risk but the opportunity to buy at the lowest price.
• Buy after breaking the neckline: The upward trend is confirmed, with lower risk but possibly missing the absolute bottom.

Key trading setup points

• Stop-loss: Set below the right shoulder low, or if entering at the neckline, use the head as the stop-loss.
• Profit target: Set at 2-3 times the stop-loss distance; even with a win rate of only 30%, this can be profitable in the long run.

The Limitations of Technical Patterns

No pattern is perfect. Investors need to be aware of two blind spots:

Fundamental changes can invalidate patterns: Tencent was still showing signs of a rebound in early December 2023, but a sudden regulatory announcement caused a 12.3% drop in a single day, instantly invalidating the technical pattern.

Patterns on low-volume stocks are unreliable: Pattern analysis is based on statistical samples; the larger the sample, the more accurate. Patterns on large-cap stocks and indices have much higher reference value than those on small-cap stocks.

Conclusion

Understanding what the neckline is, how to identify it, and when it acts—these details determine whether you can correctly use Head and Shoulders Top and Bottom for trading. But no matter how clear the pattern, it is only a high-probability statistical event, not a 100% guarantee. Combining fundamental analysis, risk management, and strict discipline is the true secret to long-term profitability.