Essential Technical Analysis for the Stock Market: How to Read the Head and Shoulders Pattern and the Inverse Head and Shoulders Pattern?

When looking at stock trend charts, you often see the "head and shoulders pattern" and the "inverse head and shoulders pattern". Simply put, the price trend resembles a person's head and two shoulders—why is this important? Because it can help you determine whether the stock price is going to fall or pump.

head and shoulders pattern: warning signal

Imagine the stock price first pumping to a high point (left shoulder), then falling a bit and pumping even higher (head), and finally pumping again but not exceeding the first high point (right shoulder). At this point, you need to be careful—not exceeding the previous high usually means a fall is coming.

Why is this happening? Because:

• Profit taking occurred when the left shoulder formed.
• Buying pressure weakens at the head, and selling strength increases.
• The right shoulder has not broken through the previous high, indicating that the upward momentum is gone.

Actual Case Study of Tencent: After the rebound at the end of 2022, it formed a head in January 2023, a right shoulder in March, and broke below the neckline (support level) at the end of April. At that time, it was 360 yuan. If you had exited then, although it was still a bit far from the high of 415, it never returned to 360 for the entire next year, and now it's only in the 200s. Exiting six months later, you wouldn't have earned any extra money; it was just a waste of time cost.

inverse head and shoulders pattern: reversal signal

The inverse head and shoulders pattern is viewed upside down. The stock price first falls to a low point, then rises a bit, followed by another drop that does not break the previous low (instead, there are people defending the price), and finally it rises again—the lows get higher and typically it will rise afterwards.

Why? Because:

• Left Shoulder: The last wave of fall rebounded, selling pressure weakened.
• Head: The lowest point appears, and everyone no longer wants to sell.
• Right shoulder: The low point is higher than the previous wave, indicating that buyers are entering the market to support the price.

How to make money with this pattern?

head and shoulders pattern short (bearish)

• Entry point: Stock price falls below the neckline
• Entry Point: Set the Take Profit (usually set at half the distance from the Entry Point to the Head)
• Tencent case: 360 entered short, exited at 305, reached the target in less than a month, why hold on until now.

inverse head and shoulders pattern long (bullish)

• Buy point 1: Buy when the right shoulder forms (price is cheap but risk is high)
• Buy Point 2: Buy after breaking the neckline (low risk but may miss the lowest price)
• Stop loss: set below the right shoulder
• Profit point: 2-3 times the stop-loss range

But be careful of these pitfalls

1. Fundamental Change

• Stocks follow the trend of morphology, but a sudden policy strike makes it all in vain.
• Tencent is a perfect example, with a flawless bottom reversal pattern, but as a result of a single statement from the government, the stock price plummeted by 12.3%.

2. Stocks with too small trading volume

• Morphology is statistics; stocks with low trading volume tend to have erratic trends, making patterns inaccurate.
• Choosing large-cap stocks and indices will be more reliable than small stocks.

3. The neckline and shoulders do not have to be perfect

• The shoulders on the left and right do not have to be at the same height, and the neckline does not have to be horizontal; these are all relative, so don't fixate on a single number.

Final Words

The head and shoulders pattern and the inverse head and shoulders pattern are merely reference tools, not guaranteed magic. Statistically, they have a certain win rate, but in practice, one must also consider fundamentals, trading volume, market sentiment, and other factors. Making the right entry and exit decisions is more profitable than rigidly adhering to a single pattern.

Core Logic: Be careful if the high does not exceed the previous high, and look for opportunities if the low does not fall below the previous low. Everything else is just details.