The pattern is believed to be one of the most reliable trend reversal patterns. It is one of several top patterns that signal, with varying degrees of accuracy, that an upward trend is nearing its end.
A pattern is comprised of three component parts:
After long trends, the price rises to a peak and subsequently declines to form a trough.
The price rises again to form a second high substantially above the initial peak and declines again.
The price rises a third time, but only to the level of the first peak, before declining once more.
The first and third peaks are shoulders, and the second peak forms the head. The line connecting the first and second troughs is called the neckline.
An inverse or reverse pattern is also a reliable indicator that can also signal that a downward trend is about to reverse into an upward trend. (As we can see in the above example)
Like all charting patterns, the ups and downs of the pattern tell a very specific story about the battle being waged between bulls and bears.
The initial peak and subsequent decline represent the waning momentum of the prior . Wanting to sustain the upward movement as long as possible, bulls rally to push the price back up past the initial peak to reach a new high (the head). At this point, it is still possible that bulls could reinstate their market dominance and continue the upward trend.
However, once price declines a second time and reaches a point below the initial peak, it is clear that bears are gaining ground. Bulls try one more time to push price upward but succeed only in hitting the lesser high reached in the initial peak. This failure to surpass the highest high signals the bulls' defeat and bears take over, driving the price down and completing the reversal.