The inverse head and shoulders pattern is a reversal pattern that occurs when prices move from a head and shoulders formation to a neckline. The breakout above the neckline offers an excellent trading opportunity.
Head and shoulders pattern is one of the several important candlestick patterns. It is a trend reversal pattern indicating potential reversal in stock price trends. It is considered as a reliable chart pattern.
Chart patterns are important trading tools in the arsenal of a stock market trader. There are different types of stock chart patterns, based on their appearance on the technical charts. Trading chart patterns give more confidence to traders and the targets are more likely to be achieved.
Apart from head and shoulders pattern (H&S pattern), they are flags, pennants, triangles, wedges, cup and handle patterns, double tops patterns and double bottom patterns to name a few.
These chart patterns are best seen on candlestick charts or OHLC charts. Candlestick chart is the most commonly used chart although OHLC chart also gives the same information.
Some of the chart patterns are the reversal candlestick patterns. That means they indicate trend reversal from the existing trend for the stock prices. Others are continuation candlestick patterns, indicating continuation of the existing trend in stock prices.
Head and shoulders pattern has another variant which is called as inverse head and shoulders pattern. It looks like an English alphabet ‘w’ on the technical charts. Hence, it can be called as w pattern also.
While the H&S pattern is a bearish chart pattern, the inverse H&S pattern is a bullish chart pattern. Both are reversal candlestick patterns. Here, we shall be discussing an inverse or inverted head and shoulders pattern.
Inverse Head and Shoulder pattern when formed shows that the previous trend of the security is coming to an end and a bullish trend is about to start.
On breakout of the pattern, traders need to be positioned on the long side to catch the big up move that the security may give.
What is an Inverse Head and Shoulder Pattern
An inverse head and shoulder pattern occurs when prices form a head, shoulders or double top pattern and then move in the opposite direction. The head and shoulders pattern can be formed on any time frame, but it’s most commonly seen on daily charts. When price action moves into the body of the head and shoulders formation, traders are looking for change in trading volumes.
Inverse Head and Shoulders pattern is formed of two shoulders which may or may not be of equal size and a head which is bigger in size than the shoulders .
A straight line joining the peaks of the shoulder and head curves makes the neckline for this pattern. This neckline can be horizontal or slanting upwards or downwards.
A pattern with upward slanting neckline is considered more strong. In routine you may not see the pattern as symmetrical as shown in figures because securities move randomly and not symmetrically. So you need to be very vigilant to spot the pattern on the chart.
After the formation of second shoulder, when the security breaks above the neckline with higher than normal volumes, it confirms the pattern.
The time taken by the pattern to complete can be days, weeks or months. The longer it takes to complete, the longer it would take to accomplish the target.
When Does the Inverse Head & Shoulde…
The inverse head and shoulder pattern is one of the most common reversal patterns used by technical analysts. It forms when prices form a head and shoulders pattern and then reverse direction. Traders use this pattern as an indicator that prices will likely continue moving higher.
How to trade Inverse Head and Shoulders Pattern?
To trade the inverse head and shoulders pattern, traders need to identify the head and shoulders pattern and determine where the neckline is located. Once they do so, they must wait until the price breaks below the neckline before initiating a position.
Break out above the Neckline is the signal for taking long positions in that security. Point to be taken care of is that volumes of the trade should be higher than average when it breaks out.
Stop loss for the trade is the lowest level touched by the stock when it was in the making of Head of the pattern. Projected target for this trade is the difference in the price of the security at the peak of shoulder 1 and the trough of the head.
Above image shows a typical inverse head and shoulders pattern. However, in this chart, the neckline is sloping downwards. For an inverse H&S pattern, the neckline sloping upwards is preferable. Upward sloping neckline gives more confidence and gives better trailing stop loss.
For H&S pattern, the downward sloping neckline is preferable.
Now, in the above chart, your tendency should be to buy stocks only when a breakout occurs above the neckline along with more than average trading volumes.
Your stop loss for the trade shall be at the lows of the shoulder 2 or more safely at the lows of the head part of this pattern.
To get the target price for the trade, substract price level at the lows of the head from the highs at the shoulder 1. Then, add this difference to the price level at the breakout level. This is your target price level.
To get a target price for the above chart pattern, we substract 165 (low point of head) from 240 (high at shoulder 1). It is 75. Breakout level was around 235. We add 75 to it and get 310. So our target for the above pattern is 310 with a stop loss at 204 or 165.
Inverse head and shoulders pattern is frequently seen chart pattern in the technical charts. You may never find a perfect pattern, but you should keep a hawk’s eye on the charts to locate it and trade it with proper risk management.
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