Inverse Head and Shoulders Pattern | My Espresso

Introduction to Inverse Head and Shoulders Pattern

An inverse head and shoulders pattern is popularly known as a “head and shoulders bottom.” It is quite similar to the standard head and shoulders pattern but typically inverted. Basically, the head and shoulders top is used for predicting reversals in downtrends.

Published on 20 December 2022

This inverse head and shoulders pattern is identified whenever the price action of security meets certain characteristics like:

  • The price typically falls to a trough and then rises high
  • The price suddenly falls below the former trough but rises again
  • Lastly, the price falls again but not quite far like the second trough.

After the final trough is made, the price typically heads upward more towards the resistance near the top of earlier troughs.

Now that you know what the pattern means, we’ll see when you should enter the trade.

Know When to Enter the Trade

While executing an inverse head and shoulders pattern, a stop loss order must be placed lower than the neckline. This must be done in anticipation of the breakout. But if you wish to place an aggressive trade, you can enter your stop loss order at the bottom of the right shoulder.

It is immensely crucial for traders to be very careful with this inverse pattern. You should remember that the first shoulder is formed right after the initial drop. Here, the bears will deliberately enter the market and try pushing the stock price downwards. Once they are successful, they can continue their control by forcing an extended downtrend.

Inverse Head and Shoulders Pattern - What are the Associated Benefits?

You should know that the first and third troughs are considered inverted shoulders. On the other hand, the second inversion is regarded as the inverted head. Those traders who can identify the pattern enter a bull position whenever the price rises above the upper resistance level. It typically follows the right inverted shoulder.

As soon as the stock index moves above this level, it refers to a sharper move higher. Besides, an increase in volume also confirms the breakout. And measuring the distance between the neckline and the head bottom, we can determine how long the bull run will last. This will probably be the same distance as the index moves or stock to the upside on a breakout.

Rules of Inverse Head and Shoulders Pattern

For an inverse head and shoulders to qualify well, two shoulders and one head must be formulated. That is to say, the second low in the pattern should be lower than the first and third lows. If this is not the case, it is merely a triple-bottom or another kind of pattern.

Similarly, a climactic price action must also be associated with the pattern. Here are a few rules for an inverse head and shoulders pattern:

  • There must be a left shoulder that displays a stopping action of the downtrend
  • It must be lower low than the first shoulder
  • The third low must be higher than the second low
  • There must be an increased volume signature along the lows of the pattern
  • It must have a solid breakout of the neckline on increasing volume

Remember that it’s important to stick to these above-mentioned rules. Only then will you be able to manage your risk levels accordingly. Thus, you must find a successful outcome with the pattern over time.

Inverse Head and Shoulders Pattern - What is the Neckline?

The neckline is a typical level of support used to determine where to place orders. And in order to identify the neckline, you must locate the left shoulder first. Then you must also locate the head and also the right shoulder on the chart. This inverse head and shoulders pattern efficiently connects the high after the left shoulder with the high after the head. Thus, the neckline is formed.

To Conclude

No matter what kind of strategy you choose, practice is the only key to success. Also, it is important for you to be aware of the odds that you are stacked against. All of these need to be done before you decide to put your hard-earned money at risk. Please ensure that you test out and know how to trade inverse head and shoulders.

And lastly, also remember that not every inverse head and shoulders pattern will work. So, determine your criteria and figure out the best way to find a confluence. But make sure that it lets you attain success while trading it.

Chandresh Khona
Team Espresso

We care that you succeed

Bringing readers the latest happenings from the world of Trading and Investments specifically and Finance in general.