Inverse head and shoulders patterns are a bullish pattern. It’s made up of a head and two shoulders. The left shoulder marks the first support level. As price rises, it goes up to make a new high, then it pulls back and falls below first support level, thus creating the head. Next up, price pulls back up to the left shoulder area, creating the right shoulder. Watch for neckline break above to confirm the breakout.
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What Are Inverse Head and Shoulders Patterns?
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 of times it’s equal. Sometimes there is a fake out which makes right shoulder lower than the left. Traders know that these patterns are major reversal patterns. They share many characteristics of their counterpart; the head and shoulders pattern. The difference being they’re upside down.
The inverse H&S pattern forms in a downtrend signaling a change in trend. In fact, they are reliable in signaling a change in direction. Volume is an important part of the inverse head and shoulders.
Inverse head and shoulders patterns form in a major downtrend. When the break out of the pattern occurs, sometimes there is a large gap up. The inverse head and shoulders patterns have a left shoulder, head, right shoulder and neckline. This pattern forms in a down trend 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 it will continue.
The left shoulder forms making a trough with a reactionary low. As a result, a new low in the trend. After the trough is made, price moves up; the high that happens 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 needs to be lower than the left shoulder this differentiates it as the head.
After making the bottom, it needs to move back up and form another high. Sometimes in a down trend, 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 form the neckline; this is a key resistance level. If the high forming the neckline breaks the downtrend trend line, the strength of the downtrend can be called into question.
Right Shoulder
The high from the head helps to form the neckline. As a result, price needs to fall to form the right shoulder. The low should be higher than the head; usually in line with the low of the left shoulder.
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 need to look at the candlesticks to better figure out is 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 is formed by connecting the reaction highs. Get these highs from the end of the left shoulder and the beginning of the head, as well as, the end of the head and beginning of the right shoulder.
In fact, they can be connected together with trend lines. The correlation between the two highs affects the patterns degree of bullishness. The neckline can slope up, down, or be horizontal.
An upward slope of the neckline is going to 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 not complete without the neckline break nor is the downtrend reversed. Resistance needs to be broken and then hold.
How to Trade Inverse Head and Shoulders Patterns
- Watch for left shoulder; first low to form
- Once first low is formed, watch for price to break below that level forming the head
- Next, look for price action to rise then fail back to left shoulder area
- Watch for right shoulder formation then hold support around 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 neckline break using a close below right shoulder as stop
