Stock Price Pattern Tips: Understanding the Profit Secrets of Head and Shoulders Top and Bottom

Why Learn Chart Patterns in Technical Analysis

In stock market investing, many rely on technical analysis to predict future trends, and chart patterns are among the most intuitive and easy-to-understand tools. Among these, the Head and Shoulders Top and Head and Shoulders Bottom are two classic formations that help traders quickly identify the formation of market tops or bottoms, thereby capturing entry and exit points. Mastering these pattern recognition skills can significantly improve trading success rates.

Head and Shoulders Bottom: Buy Signal for Reversal at the Bottom

What is the Head and Shoulders Bottom pattern

The Head and Shoulders Bottom can be seen as a mirror image of the Head and Shoulders Top, representing a process of gradual weakening of selling pressure and emerging buying strength. This pattern consists of three lows: the left shoulder, the head, and the right shoulder, with the head being the lowest point and the shoulders relatively higher.

The three stages of the Head and Shoulders Bottom

Left Shoulder Stage

During a downtrend, many bottom-fishers start entering the market. When the price rebounds to a certain level but cannot go higher, it indicates insufficient upward momentum. As more traders decide to cut losses and others look to buy cheap, the price begins to bounce back. However, due to limited buying power, the rebound cannot break previous highs, forming the first shoulder. Trading volume is relatively high at this stage, but as sellers start to accept losses, volume gradually diminishes.

Head Stage

The price falls to the lowest point of this wave. At this level, most sellers have exited, and buyers, although interested in entering, are not eager to buy at high prices. Trading volume shrinks to an extreme, which is a typical characteristic of a bottom. With light pressure, even small buy orders can push prices significantly higher. When the price rebounds near the previous neckline, it faces resistance.

Right Shoulder Stage

If the price can easily break through the neckline, a V-shaped reversal occurs. If it fails to break through once, it may decline again, but the new low will be higher than the head (i.e., a higher low). This indicates that buying is entering to support the price, and selling pressure is weakening. The formation of the right shoulder suggests an imminent uptrend.

Entry Timing for the Head and Shoulders Bottom

Traders generally have two entry points:

Signal 1: Buy after confirmation of the right shoulder

As the lows gradually rise, the highs of the wave also tend to increase. This entry point allows for a relatively low purchase price, though it carries higher risk, with greater potential returns.

Signal 2: Buy after breaking the neckline

A breakout above the neckline indicates an established uptrend, with market resistance weakening. This signal involves lower risk but may miss the lowest point.

Trading Strategy for the Head and Shoulders Bottom

Setting stop-loss and take-profit levels is crucial:

Stop-loss placement

For entries at the neckline, use the right shoulder price as the stop-loss; for entries at the right shoulder, use the head price. This allows for timely exit if the pattern fails.

Take-profit placement

Short-term traders are advised to set a take-profit at 2 to 3 times the stop-loss distance. For example, if the stop-loss is 30 points, set the take-profit at 60 to 90 points. Even with a win rate of only 30%, long-term profitability can be maintained.

Head and Shoulders Top: Sell Signal for Reversal at the Top

What is the Head and Shoulders Top pattern

The Head and Shoulders Top indicates that the head has formed, and subsequent upward movement is unable to break previous highs. The pattern consists of three peaks: the left shoulder, the head, and the right shoulder, with the head being the highest point and the shoulders relatively lower. This usually signals an impending decline.

The three stages of the Head and Shoulders Top

Left Shoulder Stage

After the initial rise, profit-taking surges, and trading volume increases. Although some investors believe higher levels are possible and continue buying, selling pressure eventually surpasses buying. The price falls back to a certain level (the neckline), forming the first shoulder. The neckline acts as an important support level.

Head Stage

Holders see the low point and buy again, and many newcomers are optimistic about the future and enter. The price rises again, even reaching new highs. However, as the price climbs, fewer are willing to buy at high levels, and volume gradually shrinks. When selling overtakes buying, the head is formed, and the price begins to reverse downward.

Right Shoulder Stage

The price declines back to the neckline, where another wave of buying occurs. These are often previous buyers at the neckline who add positions near their cost basis. The price rebounds again but cannot surpass the previous high (the head). When the price fails to make a new high and starts to fall, the right shoulder is complete, and the entire Head and Shoulders Top pattern is confirmed.

Calculation and Application of the Head and Shoulders Top Fulfillment Point

The concept of the Head and Shoulders Top fulfillment point is similar to that of the bottom pattern, used to set a target for the decline. The calculation is based on the price difference between the entry point and the previous high (the head), which serves as the reference for the downward move.

For example: Selling when the price breaks below the neckline at 360 yuan, with the head high at 415 yuan, the difference is 55 yuan. The Head and Shoulders Top fulfillment point should be set at 360 - 55 = 305 yuan. This allows for a quick profit of 55 points, avoiding over-holding.

Sell signals for the Head and Shoulders Top

Signal 1: Sell immediately when the right shoulder forms and the price breaks below the neckline

This is the clearest exit point. Once the neckline is broken, the previous support turns into resistance, and further decline potential opens up.

Signal 2: If not sold promptly, observe whether the rebound can stay above the neckline

If the price rises back above the neckline but fails to break through, reassess whether a new Head and Shoulders Top has formed. If no new pattern appears, consider selling.

Case Study: Tencent’s Head and Shoulders Top

Tencent’s stock rebounded from late 2022:

• End of November 2022: formed the left shoulder
• End of January 2023: formed the head, high around 415 yuan
• End of March 2023: formed the right shoulder
• End of April 2023: broke the neckline, entering a downtrend

At that time, a sell at the neckline (360 yuan) was appropriate. Although still below the high of 415 yuan, the stock price did not surpass 360 yuan for nearly a year and has now fallen to over 200 yuan.

Using the Head and Shoulders Top fulfillment point concept (360 - 55 = 305), the target was reached in just one month, in May 2023, allowing an exit. Compared to holding until now, this saved time and avoided the risk of a single-day plunge caused by government policy impacts in December.

Short Selling Strategy for the Head and Shoulders Top

For traders accustomed to shorting:

Entry point: When the price breaks below the neckline

Exit point: When the price rebounds and breaks above the neckline, close the position immediately, regardless of profit

Fulfillment point: Use the above calculation method, and automatically exit upon reaching the target price to avoid greed

Taking Tencent as an example, shorting at 360 yuan and setting the fulfillment at 305 yuan, it only takes about a month. Continuing to short until now, even if the price drops to 286 yuan, it’s only 19 yuan more than 305, which may not justify the time spent.

Failures and Traps in Chart Patterns

Fundamental Changes

The validity of technical patterns depends on stable fundamentals. Major changes can cause patterns to fail instantly.

In Tencent’s case, the pattern appeared perfect in early December 2023 but was shattered at the end of the month due to government policy crackdown (new regulations on online gaming), with a single-day drop of 12.3%. Such low-probability events remind us that technical analysis must always be combined with fundamental monitoring.

Targets with Low Trading Volume

Chart patterns are based on statistics; the larger the sample size, the more accurate. Assets with poor liquidity and low trading volume often cannot form regular patterns. Generally, large-cap stocks outperform small caps, and indices outperform individual stocks.

Conclusion: Chart Patterns Are Just Auxiliary Tools

Head and Shoulders Top and Bottom are among the most practically valuable pattern tools in technical analysis, but they do not guarantee profits. These patterns are probabilistic indicators derived from historical data, indicating that when such situations occur, there is a high probability of specific price movements.

Traders should use them as one of several references, combined with fundamental analysis, risk management, and continuous market monitoring, to improve long-term profitability stability. Especially by setting reasonable Head and Shoulders Fulfillment Points for entries and exits, which can effectively control risks and optimize trading costs.