Breaking Head and Shoulders Neckline

The Breaking of the Neckline Completes the Pattern

By this time, a flatter trend line can be drawn under the last two reaction lows, which is called a neckline. This line generally has a slight upward slope at tops (although it's sometimes horizontal and, less often, tilts downward). The deciding factor in the resolution of the head and shoulders top is a decisive closing violation of that neckline.

The Return Move

Usually a return move develops which is a bounce back to the bottom of the neckline or to the previous reaction low, both of which have now become overhead resistance. The return move does not always occur or is sometimes only a very minor bounce. Volume may help determine the size of the bounce. If the initial breaking of the neckline is on very heavy trading, the odds for a return move are diminished because the increased activity reflects greater downside pressure. Lighter volume on the initial break of the neckline increases the likelihood of a return move. That bounce, however, should be on light volume and the subsequent resumption of the new downtrend should be accompanied by noticeably heavier trading activity.

What has become evident is three well defined peaks. The middle peak (the head) is slightly higher than either of the two shoulders. The pattern, however, is not complete until the neckline is decisively broken on a closing basis. Here again, the 1-3% penetration criterion (or some variation thereof) or the requirement of two successive closes below the neckline (the two day rule) can be used for added confirmation. Until that downside violation takes place, however, there is always the possibility that the pattern is not really a head and shoulders top and that the uptrend may resume at some point.