The inverse head and shoulders pattern is a chart pattern traders use to identify potential bullish trends in the market.
By understanding the critical components of this pattern and how to interpret it, traders can make more informed decisions about when to buy and sell assets.
This guide explores the basics of the inverse head and shoulders pattern and provides tips for using it effectively.
What Is an Inverse Head and Shoulders Pattern?
The inverse head and shoulders pattern contains three consecutive lows. Two of these lows have equal height, while the third’s height is deeper.
Moreover, the deepest of the lows lies in the middle. It is referred to as the head of this chart pattern.
On each of its sides, two low of equal lengths are found, representing the shoulders of the pattern.
Additionally, the highest points of both shoulders are known as a “troughs”. When they are joined together by a line, the result is a neckline.
This pattern is quite easy to spot, a visual representation of this is shown below.
Additionally, this pattern forms at the end of a downtrend. After It is completed, a bullish trend reversal might begin.
How Does an Inverse Head and Shoulders Form?
The chart pattern slowly comes to life at the end of a downtrend. To begin with, in a downtrend, lower lows, and lower highs are made.
Sooner or later, the strength of sellers is bound to decrease. When this happens and a new lower low fails to form, the reverse head and shoulders pattern arises.
What Does an Inverse Head and Shoulders Mean?
The inverse head and shoulders pattern indicates a change of character. To elaborate, the structure is clearly bearish before this pattern is completed.
Upon its completion, the market fails to further decline. As a forex trader, this action should tell you the market’s cycle is changing.
The overall trend will slowly change to a bullish tone. Therefore, only buy orders should be taken at this point.
How To Trade The Reverse Head and Shoulders Pattern
After spotting the inverse head and shoulders pattern, trading it isn’t hard. Before getting to that, a few guidelines will be discussed to ensure the pattern is valid.
The neckline of chart patterns of this nature is so important. The inverse head and shoulders is not exempted from this either.
Hence, emphasis should be placed on this feature. The connection of both troughs draws this pattern’s neckline.
In the real-time chart, the neckline isn’t always a horizontal line; it is a slant line sometimes.
In the image above, both troughs were connected with a line to form the neckline.
Size of The Lows
It is vital that the lows, which represent the shoulders, are of equal lengths. As for the head, it has to be distinctly deeper than both of the shoulders by its sides.
Trading The Inverse Head and Shoulders Pattern
Let’s assume a reverse head and shoulders pattern is spotted at the end of a downtrend. The first thing to do is to draw the neckline.
In the example used below, the pattern failed. Nonetheless, the same set of rules stands.
Remember, the pattern is only valid after a break of this neckline. Hence, the waiting game has to be played here.
Depending on the type of trader you are, entries might differ. Some traders long as soon the neckline is broken. More conservative traders prefer to wait for a retest of the neckline.
Protecting capital comes first, and that isn’t overlooked. A stop loss is placed below the third low while the distance between the head and troughs determines a take profit.
Managing risk and maximizing profits with this Pattern
The inverse head and shoulders pattern is a powerful tool for traders, but it’s essential to manage risk and maximize profits when using it.
One way to manage risk is to use a stop-loss order, which automatically closes the trade if the price falls below a certain level.
Traders can also use technical indicators like the Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD) to confirm the pattern and identify potential entry and exit points.
By combining these strategies, traders can increase their chances of success when trading the inverse head and shoulders pattern.
The inverse head and shoulders is indeed a bullish reversal pattern. It forms at the end of bearish trends, and a bullish trend starts after the pattern has fully formed.
Notwithstanding, confirmation is required before this pattern is traded. A clear break of the neckline should take place first.
The inverse head and shoulders indicate the end of an uptrend and ignite a new uptrend. Traders will look to set buy orders after the neckline has been broken.
No chart pattern, strategy, or indicator is risk-free. However, their accuracy varies to different degrees. The reverse head and shoulders are generally regarded as one of the most reliable patterns in trading.