Inverse Head and Shoulders: What the Pattern Means in Trading

As the trend was strong, the trader could have used a trailing take-profit order and lifted the target. The stop-loss level could have been placed according to the risk/reward ratio and changed accordingly if there had been a trailing take profit. For a failed inverse head and shoulders pattern, a stop-loss order is placed according to the same rule as in the conservative approach. However, traders usually consider narrower stop-loss areas because the risk is higher. Then, a minor rally begins to occur as some traders think the security is oversold.

Inverse Head and Shoulders Pattern Psychology

Target minimum move equal to height of pattern measured from head to neckline. This pattern is accessible for traders of all levels, making it a versatile addition to your trading strategy. Consider practising identifying and trading this pattern, then open an FXOpen account to implement your strategy in real market conditions. Perhaps this would not be perfect for some, but it is worthwhile noting that these formations can differ significantly. Not all head and shoulders formations are made equal, and while trading them it should be noted that their profitability can rely on that ratio between the shoulder and head size. Technical analysts use a whole host of methods to find turning points in charts, be it through the use of indicators, patterns, or historical highs and lows.

How to Trade an Inverse Head and Shoulders Pattern

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

The price of the respective asset drops even lower than the left shoulder, indicating strong selling pressure. However, this extreme point often attracts bargain hunters who consider the asset significantly undervalued, leading to a rally. The Head and shoulders pattern is a reversal trading strategy, which can develop at the end of bullish or bearish trends. It is often referred to as an inverted head and shoulders pattern in… An inverse head and shoulders is a bullish signal that indicates financial market prices will rally and become bullish after the price breaks out from the pattern. Once the inverse head and shoulders pattern occurs, the next step is to enter the trade, which can be easier said than done.

Traders typically enter into a long position when the price rises above the resistance of the neckline. Try our popular premium stock charting software, with proprietary trading tools and powerful stock screens. The measured move, on the other hand, represents the distance traveled from the neckline to the objective.

1. Finally, if the price fails to hold the neckline and falls below it, a false breakout could be signaled, necessitating a strategy re-evaluation.
2. The inverse head and shoulders pattern entry price is set when the price penetrates the resistance trendline of the pattern.
3. It is not uncommon for stocks to return to an area of consolidation in order to retest the supply levels and check for demand.
4. It is a specific chart formation that predicts a bullish-to-bearish trend reversal.
5. A successful retest indicates that market sentiment on the asset has shifted from bearish to bullish, as the previous resistance level (neckline) now acts as support.
6. A successful retest of the neckline strengthens the validity of the pattern and provides additional confirmation for a bullish reversal.
7. 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.

The probability of success for inverse head and shoulders patterns.

However, this rally is short-lived as the dominant sentiment is still bearish. The inverse head-and-shoulders pattern is a major reversal signal that forms at the end of a downtrend. It has three successive troughs, with the middle trough being the deepest. As short sellers are taking profits into the lows of the pattern, bulls begin speculating on the oversold condition of the stock — taking advantage of lower prices. While the pattern matures, short sellers begin to see a potential reversal. This may lead to more short covering, which creates demand for the stock.

What are the key features of the inverse Head and Shoulders Pattern?

Float rotation describes the number of times that a stock’s floating shares turn over in a single trading day. For day traders who focus on low-float stocks, float rotation is an important factor to watch when volatility spikes. Following this formation is a bullish breakout above the resistance line connecting the two shoulders, known as the neckline.

What does inverse head and shoulders indicate?

1. The pattern also indicates that the new downward trend will likely continue until the right shoulder is broken—where prices move higher than the prices at the right peak.
2. No representation or warranty is given as to the accuracy or completeness of this information.
3. This shift culminates in a breakout above the neckline, signalling a reversal.
4. For a traditional head and shoulders formation, the pattern is created through the failure to create a new higher high, followed by the break below the prior swing low.
5. The inverse head and shoulders pattern is not a sure thing (far from it), and its presence alone is insufficient to provide traders with a significant statistical advantage.
6. The pattern appears as a baseline with three peaks, where the outside two are close in height, and the middle is highest.

A bearish head and shouders has three peaks, with the middle one reaching higher than the other two. 3 – After the right shoulder forms, pay close attention as the price approaches the neckline—the line connecting the two peaks on either side of the head. When the price breaks above this neckline, it confirms the inverse head and shoulders pattern, signaling a potential buying opportunity.

An inverse head and shoulders pattern is used by scalpers, day traders, swing traders, position traders, and active investors. An inverse head and shoulders pattern win rate is 46% from our backtesting data of 1,211 of these chart pattern formations. The S&P500 inverted head and shoulder pattern price sharply increases and penetrates through the downward sloping resistance neckline before rallying higher to the target price level, thus completing the pattern formation. Understand these 5 components helps traders identify an inverse head and shoulders in all global markets.

This downtrend faces minor support, which forms the first shoulder. The market begins to move higher, but it bounces off strong resistance, and the downtrend resumes. Next time, in the inverse head and shoulders pattern, selling volumes should increase, so the price will break below the previous low and form another one (2). In the third attempt, bears will pull the price down but won’t be able to reach the previous low (3), and the price will rebound almost at the same level as the left shoulder. After it has formed, bulls are likely to push the price above the resistance level. The resistance level, in turn, is drawn through the peaks between the head and shoulders (4).