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Inverse Head and Shoulders Patterns

How to Trade Inverse Head and Shoulders Pattern

9 min read

Inverse head and shoulders patterns are bullish patterns. It’s made up of a head and two shoulders. The left shoulder marks the first support level. As the price rises, it goes up to make a new high, then it pulls back and falls below the first support level, thus creating the head. Next up, the price returns to the left shoulder area, creating the right shoulder. Watch for the neckline break above to confirm the breakout. 

An inverse head and shoulders is an upside down head and shoulders pattern and consists of a low, which makes up the head, and two higher low peaks that make up the left and right shoulders.

The right shoulder on these patterns typically is higher than the left, but many times it’s equal. Sometimes, there is a fake out, which makes the right shoulder lower than the left.

Traders know that these patterns are major reversal patterns. They share many characteristics of their counterpart, such as the head and shoulders pattern. The difference is that they’re upside down.

The inverse H&S pattern forms in a downtrend, signaling a change in trend. They are reliable in signaling a change in direction. Volume is an important part of the inverse head and shoulders.

Inverse Head and Shoulders Picture

This is an example of an inverse head and shoulders pattern. Traders would enter a long position on the bullish candlestick that broke above the neckline. They would place their stop loss below the right shoulder area. The top area signaled a bearish trend, which could have been the start of a head and shoulders pattern.

5 Second Takeaway

  • The pattern consists of three distinct lows, with the middle low (the head) being lower than the two adjacent lows (the shoulders).
  • The lows are connected by a trendline called the neckline, usually sloping downwards.
  • The inverse head and shoulders pattern suggests going from a downtrend to an uptrend.
  •  Market sentiment is shifting from bearish to bullish.
  • Traders typically wait for the price to break above the neckline to confirm the pattern before they enter.

Basics

Inverse head and shoulders patterns form in a major downtrend. When the break out of the pattern occurs, sometimes there is a large gap. The inverse head and shoulders patterns have a left shoulder, head, right shoulder, and neckline. This pattern forms a downtrend without a previous downtrend to reverse; the inverse head and shoulders. 

Not every stock will increase in price; this is why there are two sides to trade. Short traders can employ this method. However, if the pattern completes and breaks up, scalpers on both sides can take advantage of the quick moves up while the pattern fluctuates before confirming a trend that will continue. 

The left shoulder forms, making a trough with a reactionary low. As a result, there is a new low in the trend. After the trough is made, the price moves up; the high in the decline needs to remain below trend lines to keep the downtrend. This completes the left shoulder formation of the pattern.

The head forms a new low. It must be lower than the left shoulder, differentiating it from the head. 

After making the bottom, it must move back up and form another high. Sometimes, in a downtrend, look for hammer candlesticks for a sign of a possible bounce or reversal. Once a base is hammered out and confirmed, this is known as the head of the pattern.

The high from the left shoulder and head are from the neckline; this is a key resistance level. If the high forming of the neckline breaks the downtrend trend line, the strength of the downtrend can be called into question.

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Right Shoulder

In an inverse head and shoulders, the head’s high helps form the neckline. As a result, the price needs to fall to form the right shoulder. The low should be higher than the head, usually in line with the left shoulder’s low. 

However, real-life patterns are not always perfect, so it is up to the trader to gather information from tools and charts to help make a smart trade. 

Sometimes, the right shoulder will be higher, lower, narrower, or wider. Symmetry is not as important as the neckline break. 

The right shoulder is important for the pattern to be complete. It needs that neckline break. Otherwise, the right shoulder fails, and we must look at the candlesticks to determine whether they are long-legged doji candlesticks or high-wave candlesticks.

If inverted hammer candlesticks form, the pattern breaks down. These candlesticks are giving warnings ahead of time of what might happen next.

Neckline

The neckline in an IHS pattern is formed by connecting the reaction highs. Get these highs from the end of the left shoulder, the beginning of the head, the end of the head, and the beginning of the right shoulder.

They can be connected with trend lines. The correlation between the two highs affects the pattern’s degree of bullishness. The neckline can slope up, down, or be horizontal.

An upward slope of the neckline will be more bullish than a downward-sloping neckline before the break.

Neckline Break

Volume plays a critical role in the inverse head and shoulders patterns. Without volume, there is no breakout. If there is not enough volume, any breakout is suspect.

The pattern is only complete with the neckline break, and the downtrend needs to be reversed. Resistance needs to be broken and then held.

Inverse Head and Shoulders Pattern Trading Strategy

  • Watch for the left shoulder; first low to form. 
  • Once the first low is formed, watch for the price to break below that level, forming the head.
  • Next, look for price action to rise, then fail back to the left shoulder area.
  • Watch for right shoulder formation, then hold support around the left shoulder area.
  • Some traders that a long position at break above right shoulder using a close below as a stop
  • A more cautious way to trade is to take a long above-the-neckline break using a close below right shoulder as a stop.

Inverse Head and Shoulders Price Target

To estimate the price target of the inverse head and shoulders pattern, you can measure the distance from the neckline to the head. After that, you need to project it upward from the breakout level, which provides an approximate target for the potential upward move.

The Steps Are As Follows

  1. Measure the Pattern’s Height: Measure the vertical distance from the lowest point of the head to the neckline. This represents the pattern’s height. Write down that number.
  2. Identify the Breakout Level: The breakout level is where the price breaks above the neckline. It confirms the pattern’s validity. Make sure to wait for a conclusive breakout with increased trading volume.
  3. Calculate the Price Target: Take the height of the pattern measured in Step 2 and add it to the breakout level. This will give you the price target for the potential upward move.

When an inverse head and shoulders pattern breaks out, you can estimate the price target using this method. However, it’s important to remember that the price may only sometimes reach the exact target. This could be due to many variables that influence price movements in the market.

If you’re uncomfortable doing the calculations manually, there is a solution. I suggest using other technical analysis tools, such as Fibonacci retracement levels, support and resistance levels, or other chart patterns, to validate or adjust the price targets.

Volume Importance

Like other chart patterns, confirmation of the inverse head and shoulders pattern largely depends on the volume. The volume should ideally be higher during the formation of the right shoulder and the breakout above the neckline. If the volume increases during the breakout, it indicates a stronger buying interest, which adds credibility to the pattern.

Inverse Head and Shoulders Example

SPY Inverse Head and Shoulders Pattern

This is an inverse head and shoulders chart using the tool TrendSpider. This pattern is comprised of a falling wedge pattern that forms the head. Then, a rising wedge formation formed the right shoulder area.

AAPL Chart Example

AAPL Inverse Head and Shoulders

This is an example of an inverse head and shoulders on a daily chart of $AAPL. You’ll notice that it also looks like a cup and handle pattern. Many times, cups and handles are found within this pattern.

Breakdown

Breakdown

This is an example of an inverse head and shoulders breakdown on a 5 minute intraday chart. Note that the pattern formed when price was falling intraday. Many of times when a bullish patterns like an inverse head and shoulders is forming when price is falling, then the pattern will resume it’s bearish direction.

This was the case with the example in the chart. You’ll notice that the inverse head and shoulders wasn’t really clean, especially with the right shoulder area. However, you’ll see that price never broke above the neckline area. So, the pattern looked like the inverse head and shoulders, however it never broke out. Price action failed the neckline resistance area and formed a falling wedge pattern into the after market hours.

Final Thoughts: Inverse Head and Shoulders

Inverse head and shoulders patterns have a key resistance level that needs to be broken. Once it is, the price may return to what is now supported and tested to ensure it holds.

Frequently Asked Questions

The head and shoulders reversal pattern is bearish. The opposite is the bullish inverse head and shoulders pattern.

An inverse head and shoulders is a bullish pattern. It's the reversal of a downtrend. This pattern is a bullish breakout pattern.

Many times, the inverse head and shoulders pattern has a rising neckline. Traders enter a long position once the price breaks above the top of the neckline.

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