To The Moon

What Does an Inverse Head and Shoulders Indicate? 

The inverse head and shoulders chart is thought to predict a bearish-to-bullish trend reversal and signals that a downward trend is nearing its end.

This pattern is identified when the price action of a security meets the following characteristics: the price falls to a trough and then rises; the price falls below the former trough and then rises again; finally, the price falls again but not as far as the second trough. Once the final trough is made, the price heads upward, toward the resistance found near the top of the previous troughs.

What Does an Inverse Head and Shoulders Tell You?

Investors typically enter into a long position when the price rises above the resistance of the neckline. The first and third trough are considered shoulders and the second peak forms the head. A move above the resistance, also known as the neckline, is used as a signal of a sharp move higher. Many traders watch for a large spike in volume to confirm the validity of the breakout. This pattern is the opposite of the popular head and shoulders pattern but is used to predict shifts in a downtrend rather than an uptrend.

Head & shoulders, knees & toes

Trading an Inverse Head and Shoulders Aggressively

A buy stop order can be placed just above the neckline of the inverse head and shoulders pattern. This ensures the investor enters on the first break of the neckline, catching upward momentum. Disadvantages of this strategy include the possibility of a false breakout and higher slippage in relation to order execution.

Trading an Inverse Head and Shoulders Conservatively

An investor can wait for the price to close above the neckline; this is effectively waiting for confirmation that the breakout is valid. Using this strategy, an investor can enter on the first close above the neckline. Alternatively, a limit order can be placed at or just below the broken neckline, attempting to get an execution on a retrace in price. Waiting for a retrace is likely to result in less slippage; however, there is the possibility of missing the trade if a pullback does not occur.

Still in a bear market 😉

How Should One Use the Inverse Head and Shoulders Pattern?

The most common entry point is a breakout of the neckline, with a stop below (market bottom) or above (market top) the right shoulder. The profit target is the difference between the high and low with the pattern added (market bottom) or subtracted (market top) from the breakout price. The system is not perfect, but it does provide a method of trading the markets based on logical price movements.

Limitations of an Inverse Head and Shoulders

Like all charting patterns, the ups and downs of the head and shoulders pattern tell a very specific story about the battle being waged between bulls and bears.

The initial decline and subsequent peak represent the building momentum of the prior bearish trend into the first shoulder portion. Wanting to sustain the downward movement as long as possible, bears try to push the price back down past the initial trough after the shoulder to reach a new low (the head). At this point, it is still possible that bears could reinstate their market dominance and continue the downward trend.

Trade within channel before breakout 

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