Inverted Head and Shoulder Pattern

Candlestick patterns are crucial for identifying and confirming trend reversals. When combined with suitable technical indicators, they can help you understand market movements better and predict potential price changes more accurately. The inverted head and shoulders pattern is one such bullish trend reversal indicator that you must know if you enter short-term or medium-term trades.

In this article, we will take a closer look at the pattern’s appearance, what it indicates, and how it differs from the classic head and shoulders pattern.

What is an inverted head and shoulders pattern

As the name indicates, an inverse head and shoulders pattern is the reverse of a standard head and shoulders pattern. For this reason, it is also known as the inverted or the reverse head and shoulders pattern.

It is composed of three troughs. The first and the last troughs are the shoulders, while the middle is the head. The low point of the middle trough is deeper than the low points of the shoulders. So, the pattern resembles the head and shoulders of a person — just in an inverted manner. The trendline that connects the high points of the head and shoulders is considered the ‘neckline.’

A closer look at the inverted head and shoulder pattern

The inverted head and shoulders pattern is one of the many bullish reversal signals you may find when a stock’s price attempts to rebound after a bearish phase. Essentially, here is what happens when you notice the reverse head and shoulders form on the chart:

• The first shoulder: Due to selling pressure, the share price falls and then rebounds slightly back to the neckline.
• The head: Selling pressure intensifies, leading to a deeper low in the share price. However, this time, the price again rebounds more strongly to hit the neckline.
• The second shoulder: Here, sellers again try to push the price down, but buying pressure drives it back up before it hits the deep lows of the head (or the second trough).

If the buyers dominate the market enough, the share price should break out of the neckline in the second shoulder and continue its upward trajectory. This is considered a bullish reversal.

How to confirm the inverse head and shoulders pattern?

Until you can spot a breakout, the inverse head and shoulders pattern remains unconfirmed. Along with a price breakout that goes above the neckline, there should also be a marked increase in the trading volume. It is important to make sure that the price reversal goes through with continued buying pressure. Besides these signs, the price of the asset in question should also be clearly above the neckline when it closes. If the price simply touches the neckline or is barely above it, it may not be considered a confirmation of the trend reversal pattern.

With the above-mentioned factors in mind, let us take a look at a few variations of the inverted head and shoulders pattern for a better understanding of the indicator:

• Sloping neckline
  A sloping neckline can be either descending or ascending. A descending slope is comparatively less bullish than a horizontal line. It is a sign that the prices could still fall and that the sellers are more dominant in the market. On the other hand, an ascending slope is more bullish. It indicates that buyers are aggressive in the market and are inclined to pay more.
• Complexity in head or shoulders
  The inverse head and shoulders pattern can often contain several valleys and peaks. This is a sign of a tussle between the buyers and sellers where the buyers are trying to defend the support level, and the sellers are trying to push the prices further down. If complex shoulder patterns emerge in the charts, it signifies that the buyers are unable to push prices past the resistance level and that the sellers are quickly losing momentum in the market, unable to push prices further down.
• False breakout
  A false breakout happens when the price level goes above the neckline but quickly loses momentum and falls below. One of the takeaways from observing this pattern could be that this breakout was not strong enough to reverse the prices and would need another breakout to support it. Another possibility here is that this could be a manipulation or trap put into action by the participants of the financial market.

Such a wide variety of insights necessitates that the inverted head and shoulders pattern be studied alongside other metrics and indicators in technical analysis. This can include resistance and support levels, oscillators, trendlines, and moving averages. For instance, if you draw a downtrend line that connects all the lower high price levels, it will give you a good idea and possible confirmation of price reversal if this level is broken. Moving averages can also be used to determine the broader direction of price movement.

Identifying the inverted head and shoulders

If you are planning to enter the market as a buyer after a bearish phase, you need to understand how to identify and confirm an inverse head and shoulders pattern. Here are three key things to look for:

• Three distinct troughs: The inverted head and shoulders pattern is marked by three distinct troughs, with the second one being deeper than the other two.
• The resistance level at the neckline: The neckline connects the upper points of the three troughs. It is the resistance level that the price must breach to confirm reversal.
• Trading volume: Decreasing trading volume when the price declines and increasing volumes as the price attempts a breakout indicate strong upward momentum.

Example of inverted head and shoulder pattern

In a typical inverse head and shoulders pattern, the left shoulder and the head are formed with a price downturn. Post this, as the buyers regain strength in the market, the prices rise and form the right shoulder. The high points of these two shoulders on the left and right are connected by a line known as the neckline. The confirmation of the pattern is observed when the increasing price breaks the neckline, indicating a possible bullish trend reversal.

When trading utilising the inverted head and shoulders pattern, there are two approaches that traders tend to lean towards:

• Trading aggressively
  Traders with an aggressive approach opt to enter the market at the point where the increasing price moves above the neckline. The objective here is to capitalise on the upswing to maximise profits. A good idea here is to set up a stop-loss order just under the neckline in order to minimise losses.
• Trading conservatively
  Traders who are conservative in their approach often choose to be more patient and wait for confirmation signals before entering the market. Typically, conservative traders test the price rise another time by waiting for the price level to hit the neckline after breaking above. If the uptrend continues, it is confirmation of the trend reversal and the traders enter the market.

How does the inverted head and shoulders differ from the head and shoulders pattern

In appearance and significance, an inverted head and shoulders pattern is the opposite of a head and shoulders pattern. Check out how the two differ from one another.

Inverted head and shoulders: The limitations

With the numerous aspects of the inverted head and shoulders patterns now clear, it is also important to know about some drawbacks and limitations of the bullish price reversal pattern. These are:

• False signal
  Much like several other signals under technical analysis, the inverted head and shoulders pattern is also prone to giving false signals. This makes it even more important to rely on accompanying trend confirmation indicators before entering the market.
• Conditions of the market
  Even though the inverted head and shoulders pattern is instrumental for every trader, it is vulnerable to changes in market conditions. A solid fundamental grasp of the market conditions is essential before employing the bullish reversal pattern.

Conclusion

The inverted head and shoulder pattern is not a standalone indicator of possible trend reversals. To make a smart trading decision, you must pair it with other indicators and confirmation signals. Then, depending on your risk profile, you can determine the entry point and the target price.