The inverse head and shoulders pattern is a technical analysis chart pattern. It can signal a potential trend reversal in the market. Traders often use this pattern to identify buying opportunities and make profitable trades.
Inverse Head and Shoulder pattern shows that a bullish trend is about to start after the previous downtrend. It looks like an English alphabet ‘W’ on the technical charts. Hence, it can be called as W pattern also.
Inverse Head and shoulders pattern is opposite of Head and Shoulders Pattern which is like alphabet ‘M’. It is a bearish chart pattern.
What is an Inverse Head and Shoulder Pattern
The inverse head and shoulders pattern is a bullish reversal pattern that forms after a downtrend.
It consists of three lows. The middle low (the head) being lower than the two surrounding lows (the shoulders). The pattern is complete when the price breaks above the neckline. The neckline is a level of resistance that connects the highs between the two shoulders.
The shoulders may or may not be of equal size and the head is bigger in size than the shoulders. Neckline can be horizontal, slanting upwards or downwards.
Traders often look for this pattern as a signal to enter a long position. The stop loss for the trade is below the neckline. The profit target is at least equal to the distance between the head and the neckline.
A pattern with upward slanting neckline is considered stronger. In routine you may not see the pattern as symmetrical as shown in figures. This is because the 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.
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 the Inverse Head and Shoulders Pattern
To trade the inverse head and shoulders pattern, breakout above the neckline is the signal for taking long positions in the stock. Point to be taken care of is that volumes of the trade should be higher than average at breaks out.
Above candlestick chart shows a typical inverse head and shoulders pattern. However, in this chart, the neckline is sloping downwards. The neckline sloping upwards is preferable which gives more confidence and a better trailing stop loss.
The most common entry strategy is to wait for the price to break above the neckline, confirming the pattern’s completion. This breakout serves as a signal to enter a long position, anticipating a bullish move. To avoid false breakouts, traders often wait for the price to close above the neckline or use a certain percentage threshold.
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. The 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 inverse head and shoulders pattern target price for the trade, subtract 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.
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.
Common Mistakes to Avoid when Trading The Pattern
While the inverse head and shoulders pattern can be a profitable trading strategy, it is essential to be aware of common mistakes that traders should avoid.
One common mistake is jumping into a trade without proper confirmation. Traders should wait for the price to break above the neckline and confirm the pattern’s validity before entering a position. Premature entries can lead to false signals and potential losses.
Another mistake is neglecting risk management and position sizing. Traders should always define their risk tolerance and set appropriate stop-loss levels. Failing to manage risk effectively can result in significant losses and hinder long-term profitability.
Lastly, overtrading can be detrimental to trading success. Traders should focus on high-probability setups and avoid trading every inverse head and shoulders pattern they encounter. Quality over quantity is key when it comes to trading this pattern.
Advanced Techniques and Variations of The Inverse Head and Shoulders Pattern
While the basic inverse head and shoulders pattern is highly effective, advanced traders may explore variations and additional techniques to enhance their trading strategies.
One variation is the multiple inverse head and shoulders pattern, where several smaller patterns form within a larger one. This indicates multiple potential trend reversals and can provide additional trading opportunities.
Other techniques include combining the inverse head and shoulders pattern with other technical analysis tools, such as trendlines, Fibonacci levels, or moving averages. These combinations can offer more robust confirmation signals and increase the probability of successful trades.
Exploring these advanced techniques and variations allows traders to refine their trading strategies and adapt to different market conditions.
Key Takeaways for Successful Trading using the Inverse Head and Shoulders Pattern
The inverse head and shoulders pattern is a powerful tool for identifying potential trend reversals and capturing profitable trading opportunities. By understanding its anatomy, confirming the pattern, and implementing effective entry and exit strategies, traders can increase their chances of success.
1. Understand the anatomy of the pattern: Recognize the left shoulder, head, and right shoulder of the pattern.
2. Identify the pattern on price charts: Look for the distinctive shape and confirm the pattern with volume analysis.
3. Consider confirmation signals and factors: Analyze market context, look for bullish divergences, and prioritize higher timeframe patterns.
4. Implement entry and exit strategies: Enter trades after the neckline breakout and set profit targets and stop-loss levels accordingly.
5. Practice proper risk management and position sizing: Determine your risk tolerance, set maximum acceptable losses you can bear and calculate the position sizes based on risk-reward ratios.
6. Learn from real-life examples: Study successful trades using the inverse head and shoulders pattern to gain insights and confidence.
7. Avoid common mistakes: Don’t enter trades without confirmation, neglect risk management, or overtrade.
8. Explore advanced techniques and variations: Consider multiple patterns and combine the inverse head and shoulders pattern with other technical analysis tools.
By applying these key takeaways, traders can crack the code of the inverse head and shoulders pattern and unlock the potential for profitable trading. Start analyzing price charts, practicing with historical data, and refine your skills to become a successful trader in various financial markets.
Managing Risk and Staying Disciplined
Successful trading requires effective risk management and position sizing. Trading the inverse head and shoulders pattern is no exception. Proper risk management ensures that potential losses are controlled. It allows traders to preserve their capital and stay in stock trading for the long term.
You should always use stop loss orders to limit potential losses. Never risk more than you can afford to lose. It’s also important to stick to a trading plan and not let emotions drive decision-making.
You should have a clear exit strategy in place and be prepared to cut losses if the pattern fails to play out as expected.
Inverse head and shoulders pattern is one of the frequently seen chart patterns in the technical charts. You may never find a perfect pattern. However, you should keep a hawk’s eye on the charts to locate it and trade with proper risk management.