Understanding the Inverted Head and Shoulder Pattern

Technical analysis patterns are perfect for understanding the market shift. Gravestone Doji, ‘cup and handle’, and ‘head and shoulders’ patterns are essential for technical analysis. You can understand the market sentiment through these patterns. Some of you might have heard of the head and shoulders pattern. An inverted head and shoulder pattern is the opposite of the head and shoulders pattern. Read on to understand more about the inverse head and shoulders pattern.

What is the Inverse Head and Shoulders?

The ‘inverse head and shoulders’ is a pattern discovered after price action sequencing. It is observed after you plot the price of an asset through price action. It is a bullish reversal pattern that indicates the formation of a bullish market. It is usually observed after a downtrend in the market. The shape of the inverted head and shoulders pattern is exactly the opposite of the head and shoulders pattern. The pattern consists of three troughs, with the middle one known as the head. The two shoulders surrounding the head have significantly lesser lows. The inverted head and shoulder pattern is a signal of weakening bearish sentiment in the market. Buyers are expected to dominate the market after the completion of an inverted head and shoulders pattern.

How to Trade Inverse Head and Shoulders Patterns?

You can use the inverse head and shoulders pattern for trading. Here’s how to use this pattern for making trading decisions:

  • You must start by confirming the formation of the inverted head and shoulders pattern. Look for a downtrend where the shoulders have higher lows when compared to the head.

  • Locate the neckline in the pattern. It is the high of the third shoulder where the price starts to break. This price at the breakout point will be your entry point in the market.

  • You must also place stop-loss orders to remove the risk of potential losses in case the market takes an unexpected U-turn. Place stop-loss orders below the low of the inverted head and shoulders pattern.

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  • Calculate the distance between the head and neckline. Add the distance to the breakout point to get the price target. It will give you an idea of how far the price of the asset might rise.

How to Read an Inverse Head and Shoulders Pattern?

New investors in the market often misinterpret the inverse head and shoulders pattern. It might lead to poor trading decisions and potential losses. The inverted head and shoulders pattern represents the end of a bearish trend. It also represents an upcoming bullish trend in the market. When the price rises above the breakout point in the pattern, investors take long-buying positions in the market. The inverse head and shoulders pattern also helps identify the potential profit levels during the upcoming bullish trend. However, it can happen only when you read the pattern effectively.

The first step is to identify the formation of an inverted head and shoulders pattern. Look for a downtrend where three troughs are formed. The ups of three troughs will not go beyond a certain price. A certain level of the price acting as a barrier is called the neckline. The middle trough is called the head and has a relatively longer depth. The lows of the left and right shoulders will be less than that of the head. Also, the head must appear between the two shoulders, having a relatively lesser low. When the head does not have the lowest point, the pattern is not complete. The lows of both shoulders might be almost or entirely the same.

After the formation of the second shoulder (rightmost), the price might break the barrier of the neckline. When the price rises above the neckline, it is a confirmation of the inverted head and shoulders pattern. The price is expected to rise for a while after it breaks free from the neckline. In short, the downtrend consists of three lows, with the lowest point being the head. Investors must keep track of the trading volume when an inverted head and shoulders pattern appears. The trading volume diminishes during the formation of the pattern. However, the trading volume increases when the price breaks above the neckline after the formation of the rightmost shoulder.

Some investors might face issues while determining the resistance or neckline of the pattern. You can join the end-high of the first shoulder and the end-high of the head to get the neckline. Once the price goes beyond the neckline after the pattern completion, you can start taking long positions in the market.

The inverse head and shoulders pattern also allows investors to determine their potential profit levels. You must indicate the head to do so, which has the lowest low in the pattern. Find the gap between the head and the resistance or neckline, and project it above the neckline. It will give you an idea of the price target during the bullish trend. It is crucial to note that the bullish trend will appear only after the completion of the inverted head and shoulders pattern. Also, do not take long market positions before the price goes beyond the neckline, thus indicating the start of rising prices.

Trading in Inverse Head and Shoulders

Inverse head and shoulders pattern stocks are used by many traders. Beginners in the stock market must interpret the pattern accurately, otherwise, it may lead to potential losses. You must have an understanding of the three troughs, the head and two shoulders. Beginners often confuse the inverted head and shoulders pattern with the head and shoulders pattern, which might lead to trading disasters. Here’s how you can trade conservatively and aggressively with the inverted head and shoulder pattern:

Aggressive Trading

Many traders are aggressive and jump on an opportunity as soon as they see it. You can start trading aggressively as soon as the price goes beyond the neckline or breaks free. You can take long-buying positions in the market to earn maximum returns. You can get an early entry into the bullish market as soon as the bearish trend reverses. However, there is an issue with aggressive trading through the inverted head and shoulder pattern. The price might go above the neckline, but it could be a false break. The price might plummet again after it breaches the neckline. Investors with a high-risk appetite must trade aggressively with the inverse head and shoulders pattern.

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Conservative Trading

Conservative traders can take some time after the completion of an inverted head and shoulder pattern. You can wait a few days for the asset price to rise above the neckline. You can take entry into the market after the price has significantly crossed the neckline. It will confirm the trend reversal and start of a bullish market. Also, there will not be any chance of price retrace or false breakout. However, there is an issue with conservative traders using the inverted head and shoulders pattern. When the price never falls back and continues to rise, you might miss out on buying opportunities. You could have gotten the asset at a lower price with aggressive trading. The idea is to make trades based on your risk appetite.

Limitations

Like any other technical analysis pattern, the inverted head and shoulder pattern has some limitations as well, which are as follows:

  • The inverse head and shoulders pattern might give false signals at times. You might think the price has reached above the neckline, but it might fall back again.

  • The inverted head and shoulders pattern is a technical analysis tool. It only gives insights regarding the price of a particular asset. It does not consider the fundamental factors related to the issuer of the asset.

  • The inverted head and shoulders pattern might be complex to understand at first for stock market beginners.

  • The time taken for the completion of an inverted head and shoulders is not definite or fixed.

Difference Between Inverse Head and Shoulders and Head and Shoulders

Both ‘inverse head and shoulders’ and ‘head and shoulders’ consist of a head and two shoulders. However, there are several dissimilarities between the two patterns, such as: 

Inverse Head and Shoulders  Head and Shoulders 

It signals an upcoming bullish trend. 

It signals an upcoming bearish trend. 

The pattern has an upside-down head and shoulders shape. 

This pattern has a normal head and shoulder shape.  

It occurs after a downtrend. 

It occurs after an uptrend. 

You must measure the distance between the head and neckline and add it to the breakout point to know the target price. 

You will find the gap between the head and neckline and subtract it from the breakout point to know the target price. 

Conclusion

The inverse head and shoulders pattern can help investors identify an upcoming bullish trend. Investors must look for two shoulders and a head in between to confirm the pattern. Also, the head has the lowest price in the pattern. Investors can use the breakout point of the pattern to take entries in the market. It is better to use the inverted head and shoulder pattern in conjunction with other technical analysis patterns for accuracy. Start using the inverted head and shoulders pattern for trading now! 

 



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