The best-known reversal pattern. Here is what it looks like, where the neckline runs, how to calculate the target, and why the pattern can't be traded before the break.
Three peaks: the middle one (the head) is higher than the two outer ones (the shoulders). A reversal after a rally.
Neckline
A line through the lows between the shoulders and the head. The pattern's key level.
Entry
A close below the neckline or a retest of it from below.
Target
The height from the head to the neckline, projected down from the breakout point.
What the pattern looks like
Head and shoulders appears at the end of an upward move. Price makes a high (the left shoulder), then a new, higher high (the head), then fails to beat it and forms a lower peak (the right shoulder). The lows between the peaks form the neckline.
In essence it's a break of structure: the right shoulder is the first lower high, and the neckline break is the first lower low.
Left shoulder, head, right shoulder and a neckline break. The dashed line is the target based on the pattern's height. Illustrative data.
How to trade it
01
Wait for the right shoulder
Without it, it's just a pullback in a trend.
02
Draw the neckline
Through the lows between the shoulders and the head. It can be slightly sloped.
03
Enter after a close below the line
Or on a retest of the neckline from below: the stop is tighter that way.
04
Stop above the right shoulder
If price returns above the right shoulder, the pattern is broken.
05
Target the pattern's height
The distance from the head to the neckline, projected down from the breakout.
Inverse head and shoulders
The mirror pattern at the end of a downtrend: three troughs, the middle one lower than the outer ones. A break of the neckline upward is a buy signal, and the target is calculated the same way.
The most common mistake is shorting the right shoulder "because the pattern is almost done". Until the neckline breaks, it's still an uptrend with a pullback, and the pattern may never complete.
Common mistakes
Seeing the pattern in every pullback
Head and shoulders is a reversal after a notable rally. In the middle of a range it's not a pattern.
Entering without a close below the neckline
A poke through the neckline and back is a common trap.
Waiting for the exact target
The height target is a guide. Take partial profits earlier, especially near strong levels.
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