Inverse Head and Shoulders Pattern: Overview, How To Trade, Set Price Targets & Examples

An inverse head and shoulders pattern is a reversal pattern, forming at the end of a bearish trend. An inverse head and shoulders formation gets its name as it resembles an inverted head with two shoulders shape. An inverse head and shoulders pattern is also known as a “head and shoulders bottom” or a “reverse head and shoulders” and it is a bullish signal.

What Happens After Head and Shoulders Pattern?

In this case, the stock’s price reaches three consecutive lows, separated by temporary rallies. An inverse head and shoulders pattern stock example is shown on the daily stock chart of Alibaba stock (BABA) above. The stock price forms an inverse head and shoulders after a price consolidation period. Alibaba price moves higher and breaks out above the neckline area before trending in a bullish direction to the trade exit level. As with everything in trading, one indicator or pattern is rarely enough to make a decision. The first step in trading an inverse head and shoulders pattern is to identify the pattern.

The best way to trade an inverse head and shoulder pattern is to start by identifying the left shoulder, head, and right shoulder. The next step is to determine an entry point based on the distance from the neckline to the head. Traders enter the long position at this point and place a stop-loss order. The profit target is decided by the traders by measuring the gap between the head and the neckline. This chart pattern is a comprehensive trading strategy when used correctly. An inverse head and shoulders pattern is also a reliable indicator, signaling that a downward trend is about to reverse into an upward trend.

The head and shoulder bottom, or reverse head and shoulders, occurs after a downtrend and signals a potential reversal to the upside. The inverse head and shoulder pattern is considered a bullish reversal pattern. The inverse head and shoulders pattern is a powerful tool for identifying market reversals. Combining it with technical analysis indicators of different types, such as trend, momentum, volatility, and volume, can potentially enhance the accuracy of its signals. An inverse head and shoulders pattern, sometimes known as an inverted head and shoulders pattern, is a chart formation that appears at the end of a downtrend.

1. It is used by traders and analysts to provide valuable insights on potential trend reversals.
2. However, it has some limitations that should be considered before entering a live market.
3. As you can see, a proper head and shoulders can offer multiple “cheat entries” if you are trying to layer into a position in anticipation.
4. The trader can choose the time frame depending on his preference.
5. Candlestick patterns are rarely as uniform as pictures often suggest, but formations should still be visible to a practiced eye.
6. A head and shoulders pattern consists of a peak followed by ahigher peak and then a lower peak with a break below the neckline.

The Inverse Head and Shoulders: Trading Rules

The first component of an inverse head and shoulders pattern is a lead-in downtrend, which is a clear downward trend in the price of the asset. This downtrend is typically characterized by a series of lower lows and lower highs. The pattern’s bullish signal is confirmed when prices break through the neckline resistance level after forming the right shoulder. The two low points between the head and shoulders form the neckline, which acts as a support level.

It represents a possible exhaustion point in the market, where traders can begin to look for buying opportunities as the market establishes a bottom and starts to climb higher. Short squeezes can introduce a lot of volatility into stocks and send share prices sharply higher. These squeezes offer opportunities for trading, but they often require different strategies and more caution than traditional breakouts.

The inverse head and shoulders pattern entry price is set when the price penetrates the resistance trendline of the pattern. Watch for increasing buying volume and bullish momentum as the price increases above the neckline resistance level. The subsequent decline, forming the inverted head, represents a further price dip to a lower swing low price. The inverted right shoulder is caused by the asset price making another upward move, signaling inverted head and shoulder pattern that buyer strength is present and a bearish-to-bullish trend reversal is beginning. The very best way to identify a profit target for an inverse head and shoulders pattern is through the combined use of a measured objective along with key support and resistance levels. This is the extended move down that eventually leads to exhaustion and a reversal higher as sellers exit and buyers step up.

How Accurate Are Inverse Head and Shoulder Patterns?

Inverse head and shoulders alternative bullish reversal patterns are listed below. The formation of the inverted head marks a market bottom, often indicative of heavy selling reaching a climax with peak negativity. The inverted right shoulder follows, characterized by a rise as buyers cautiously re-enter the market, signaling a shift in sentiment from extreme negativity to cautious optimism. In a typical downward trend, prices first drop to a low point before rebounding to a resistance level, forming the left shoulder. The downtrend resumes, creating a deeper low, which constitutes the head.

The first thing to understand is that there is a difference between the measured objective and what’s called the measured move. Without waiting for the close it’s possible for the market to spike above the neckline, trigger your buy order, and then settle back below the neckline without ever closing above it. So far you’ve learned the five characteristics of the inverse head and shoulders.

The past performance of any trading system or methodology is not necessarily indicative of future results. This pattern illustrates a gradual shift in the balance of power between buyers and sellers, with the downward trend slowing down. The right shoulder forms when the downtrend weakens, and prices do not fall below the low established by the head. Fibonacci retracement levels also connect any two points that the trader views as relevant, typically a high point and a low point. This can be used by traders to connect the highs and lows in an inverse head and shoulder pattern. The upside-down head and shoulders formation is an approach that can be used easily by traders with any level of experience.

The Head and Shoulders Pattern: How to Trade Tops and Bottoms

High volume during the breakout suggests that the upward trend is more likely to be sustained, as it shows strong buyer commitment. Alternately, some traders will hold out longer for their entry, with a reversal back into the neckline after an initial breakdown providing that sell signal. This allows for greater confirmation that price action can sustain below that neckline. However, it also increases the likeliness that a trader will miss the entry, with a rapid breakdown often meaning no such retest occurs. One of the most popular patterns is the head and shoulders, which is commonly used to find market reversals.

This ensures that the rest of the market is on-board with the breakout, which means you are less likely to experience a false break. By using a buy stop order above the neckline, you aren’t waiting for the market to close above resistance. The idea here is to catch the market as it breaks through neckline resistance. You know how to identify the pattern as well as how to determine when the pattern is confirmed. Now it’s time for the really fun part – how to trade (and profit) from this pattern.

1. Once the inverse head and shoulders pattern occurs, the next step is to enter the trade, which can be easier said than done.
2. This provides valuable insights that help the traders make the right trading decisions.
3. You know how to identify the pattern as well as how to determine when the pattern is confirmed.
4. Furthermore, the accuracy of inverse head and shoulders patterns is often imperfect.
5. On this occasion, we would be looking at a loss of around 500 points, with a profit of 800.
6. Trading the pattern in the direction of the breakout offers a high probability reversal setup.

Remember that false breakouts can occur, so it’s essential to use additional technical indicators to confirm the validity of the pattern. Finally, traders should set stop-loss orders to manage their downside risk, especially when trading on these pattern breakouts. Each situation is different in trading, yet as a rule of thumb, a head and shoulders breakdown would mean you will want to look at the prior swing high for stop losses.