In this dynamic world of trading, identifying imminent reversal of the market is propietary to any trading strategy you and the inverse head and shoulder pattern stand as a notable indictor. the pattern is popular for identifying bullish reversal and it’s characterized by three distinct troughs.
In this guide, we will see what an Inverse Head andShoulder is, how it is formed, as well as its interpretation.
Inverse Head and Shoulders | Definition
Inverted Head-Shoulder-Head (HCHI) is a bullish chart pattern that is formed when prices reach it minimum with three successive low with the middle low showing the deepest with two shallower outside lows. This configuration is considered a trend reversal pattern and can be a signal that the market is becoming bullish.
The pattern is one of the most common technical analysis patterns and is considered one of the most reliable. It is a change of direction pattern, which means that the market may be ready for a change to turn around.
When traders detect this signal they have to prepare for a possible change of direction, which involves opening long positions if the pattern is confirmed. Consequently, some aspects to be taken into account when operating with the HCHI include volume knowledge, support and resistance patterns and the behavior of volatility.
How to use the Inverted Head and Shoulders?
You can detect the formation of an Inverted HCHI to take advantage of it in your trading. Just follow the steps below to detect and maximise the opportunity:
Step 1: Identifying the inverted head and shoulders pattern
Now that you know what an Inverse Head and Shoulders is, it’s time to look for it in price charts. The pattern is characterized with three troughs: a lower ‘head’ between two higher ‘shoulders giving a potential reversal position from bearish to bullish.
Look for three descending consecutive lows that present the following form to identify an inverse head and shoulder.
- The Left Shoulder (1st Shoulder): After a downtrend, the price chart of the asset makes a low and then accumulate to a higher point first the first low.
- The Head: The formation of the first low (left shoulder) may stimulate a further price decline forming a point lower than the left shoulder an d then accumulate again to form the head. Then you will see a lower low than the previous one.
- The Right Shoulder: This is a further price decline but not as the left shoulder and the head. It then accumulate again to form the right shoulder. Typically, the left and right shoulder are almost equal in depth.
Step 2: Establish resistance levels (or neckline)
The level of resistance is set at the highest point between the head and shoulders. This is called the “neckline” or “clavicular line.“
The Neckline is a trendline drawn connecting the high peaks after the formation of each shoulder and the head. It serves as a resistance line the pattern must breakthrough to certify the credibility of the pattern.
Of course, this line must be respected at all times, if at any time the price action breaks it, you can go on long position in addition to using other technical indicators. It can only be broken when the second shoulder is forming, and consequently, the price is in a position to start turning abruptly.
Step 3: Confirm the market volume
Volume plays a significant role inn validating the strength of an inverse head and shoulders chart pattern. During the left shoulder formation of the pattern, the volume decreases as the left shoulder form, showing the indicating the selling pressure.
For the head of the patttern, volume may spike at the low point of the head as panic selling engross the bears. And the right shoulder volume is usually lower compared to the head, signaling a diminishing selling pressure.
During the pattern breakout of the neckline, a significant increase in volume is formed which is a strong confirmation of the pattern.
Volume serves as the confirmation of the chart pattern as high volume projects that the breakout is not false. Also, a volume supported breakout leads to a stronger and and more rapid price movement, making it easier to reach the profit target.
In addition, the knowledge of the market volume help in risk management as low volume breakout is a red flag signaling that the pattern may not be as reliable which aid risk management
Step 4: Risk management
Effective risk management while placing a trade minimize losses that occur as a result possible trade reversal and net loss. To manage risk, ensure you set a Stop Loss order. Place the order slightly below the right shoulder or the neckline to minimize potential losses.
Also, you should determine the volume (size) of your trade base on your risk tolerance.
Step 5: Profit target
Now that you have established the support and resistance levels, as well as the tracking of the your position sizing, the next step is to set a profit target.
Typically, your profit target should be the vertical resistance level plus the same number of points as the space between the minimum support level (the head) and the neck (or clavicular line). This is the maximum amount of profit expected from a transaction.
At what moment can an Inverse Head and Shoulders be nullified when it is forming?
There are several factors that can cause the nullification of an Inverted HCH, they include:
- Moment when the pattern is formed: If the formation of the pattern occurs too close to a resistance or support zone, it is likely that the price will remain in that zone and not move to a higher or lower level. This will make the pattern null and void and cannot be used to trade.
- Volume of operations: If the volume of operations is low, it is likely that the currency price will not move enough to form the pattern so it will be cancelled before it can be used to trade.
- Macroeconomic environment: It is possible that the currency price will move in a different direction than expected and the inverse head and shoulders pattern will be cancelled before it can be used.
In what circumstances does the Inverse Head and Shoulders pattern have more strength?
The inverse head and shoulder is a pattern that works when the market is in a downward or sideways trend. In addition, the pattern is based on the theory that prices will move in opposite directions.
The trading volume is an important indicator that can help evaluate the strength of the trend. If the trading volume is high, it means that there is a strong trend in the market and it is more likely that the pattern is true.
Support and resistance levels should also be taken into account before evaluating the benefits of the pattern. These levels are generally found at the extremes of a trend and can be an indicator of the direction in which the price will move. If there is a strong support and resistance level, it is more likely that the inverse head and shoulders pattern will work. On the other hand, if the support and resistance levels are weak, it is less likely that the pattern will be effective.
Pros and cons of using the Inverse Head and Shouders in your trading strategy
Pros of using the Inverted HCH in your trading strategy inclue:
✅ Predictability: Helps a potential change from a bearish to a bullish trend
✅ Reliability: It is attributed certain reliability, if the volume accompanies.
✅ Depth: It is a somewhat more complex figure, several things have to happen for it to form.
✅ It is a useful tool to help you identify support and resistance levels
✅ Helps identify buy and sell signals
Cons of using the Inverted HCH in your trading strategy include:
❌ Subjectivity: It is easy to identify but it is also easy to make mistakes. If you don’t know basic trading concepts well, it is likely that you won’t identify it correctly
❌ Emotions: It is often used to predict the exact moment when a trend will change and this can be a problem, since many traders don’t have the necessary discipline to wait for the exact moment when the trend will change.
Nevertheless, the Inverse head and shoulders can be a useful trading tool, but there are some important risks that you should consider before using it. It is important that you have a solid trading plan and that you control your risk to avoid these problems.
FAQs about the Head and Shoulders pattern
What Asset can I Use Inverse Head and Shoulders Chart Pattern?
The inverse head and shoulders chart pattern is a versatile trading pattern that you can find on the price chart of any asset. With the knowledge of how the pattern works, you can make your financial decisions.
What is the best Timeframe for the Inverse head and Shoulders Pattern?
There is no special timeframe to trade this pattern. You can use the pattern knowledge in any timeframe you observer it. The best timeframe is objective to each trader
How reliable is the Inverse Head and Shoulders Pattern?
The reliability of the pattern is based on market condition, trader’s experience, asset being traded, and the timeframe used. Therefore, one cannot explicitly say the pattern is hundred percent accurate.
Can I Use Other Technical Indicator with the Head and Shoulder Pattern?
You can use some other technical analysis indicators combined with the above chart pattern. Some of them include, moving averages, the RSI, the MACD, the volume oscillator, and the stochastic oscillator.