The inverse head and shoulders pattern is a signal of an impending reversal. It forms at the end of downtrends shifting structure to the upside.
This pattern shares every characteristic with the regular head and shoulders, the only difference is it’s inverted (upside down).
It is a popular forex trading pattern as revealed in our top 15 forex chart pattern cheat sheet.
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 and they represent 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, before this pattern is completed, the structure is clearly bearish.
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 to ensure the pattern is valid will be discussed.
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. This pattern’s neckline is drawn by the connection of both troughs.
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 important 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 a take profit is determined by the distance between the head and troughs.
The inverse head and shoulders is indeed a bullish reversal pattern. It forms at the end of bearish trends and after the pattern has fully formed, a bullish trend starts.
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.
Summary: How To Trade The Inverse Head and Shoulders Pattern
No chart pattern, strategy, or indicator is risk-free. Although their accuracy varies to different degrees. The reverse head and shoulders are generally regarded as one of the most reliable patterns in trading.