Breaking the Neckline

Breaking the Neckline
The real tip-off appears when activity fails to pick up appreciably on the third
rally, the right shoulder. If the market remains dull as prices recover (at which
stage you can draw a tentative “neckline” on your chart) and if, as they
approach the approximate level of the left shoulder Top and begin to round
over, volume is still relatively small, your Head-and-Shoulders Top is at least
75% completed. Although the specific application of these pattern studies in
trading tactics is the province of the second part of this book, we may note
here that many stock traders sell or switch just as soon as they are sure a lowvolume
right shoulder has been completed, without waiting for the final
confirmation which we named under D as the breaking of the neckline.
Nevertheless, the Head-and-Shoulders is not complete, and an important
Reversal of Trend is not conclusively signaled until the neckline has
been penetrated downside by a decisive margin. Until the neckline is broken,
a certain percentage of Head-and-Shoulders developments, perhaps 20%,
are “saved”; i.e., prices go no lower, but simply flounder around listlessly
for a period of time in the general range of the right shoulder, eventually
firm up, and renew their advance.

Finally, it must be said that, in rare cases, a Head-and-Shoulders Top is
confirmed by a decisive neckline penetration and still prices do not go down
much farther. “False moves” such as this are the most difficult phenomena with
which the technical analyst has to cope. Fortunately, in the case of the Headand-
Shoulders, they are extremely rare. The odds are so overwhelmingly in
favor of the downtrend continuing once a Head-and-Shoulders has been confirmed
that it pays to believe the evidence of the chart no matter how much it
may appear to be out of accord with the prevailing news or market psychology.
There is one thing that can be said and is worth noting about Head-and-
Shoulders Formations that fail completion or produce false confirmations.