The inverse head and shoulders chart pattern is a helpful tool for finding positive reversals in the fast-paced trading world. This Pattern has three clear troughs: a lower “head” between two higher “shoulders.” If the price breaks above the “neckline,” it could mean that the direction is changing from bearish to bullish.
Traders often enter the position at this breakout point, place stop loss orders below the right shoulder, and use technical analysis indicators like the moving average, the Relative Strength Index (RSI), and the Moving Average Convergence Divergence (MACD) to get more confirmation. This gives them a complete way to take advantage of these trading opportunities.
What are Head and Shoulders Backward?
As a bullish chart pattern, the inverse head and shoulders pattern shows that a decline might be about to end. This design is the opposite of the head and shoulders pattern, showing that prices are decreasing.
“Inverted Head and Shoulders” is a stock market strategy.
The inverted head and shoulders chart pattern is made up of three troughs. The “shoulders” are the first and third troughs about the same depth, and the “head” is the second, more profound.
How to Read the Inverse Head and Shoulders Chart Pattern
In technical analysis, this chart pattern formation is often used to guess when a downtrend will stop. The regular head and shoulders chart pattern is a negative indicator, but this one is the opposite. It shows that prices are going up. The inverse head and shoulders chart design is made up of the following parts:
Left Shoulder: The price of an object hits a low point after going down, then rises to a higher point, making the left shoulder.
Head: The price drops below the left shoulder after the left shoulder forms, then rises again, making the head.
Right Shoulder: Finally, the price goes down again, but not as much as the earlier drop or the head. It then rises again, making the right shoulder. The depth of the right shoulder is usually about the same as the depth of the left shoulder.
Neckline: A trendline is made between each shoulder’s and the head’s high points (also called “peaks”). The price must break through this line, which acts as a barrier, to show that the Pattern is actual.
The thoughts that led to the creation of the inverse head and shoulders Pattern
During its formation, traders’ and buyers’ changing emotions created the inverse head and shoulders pattern. This helps us understand the psychology behind it.
The general feeling on the left shoulder is negative. The buyers still have power. Then, there is a slight recovery because some traders believe the stock has been sold cheaply. But this rise won’t last long because most people are still bearish.
Next, when the head of the inverse head and shoulders pattern forms, people’s mood changes from being very pessimistic to cautiously hopeful. The price of that asset falls even more than the left shoulder, which means there is a lot of pressure to sell. The drop to a new low could lead to panic selling. On the other hand, value investors often come in at this point because they think the asset is significantly undervalued. This causes a rally.
Now, the right shoulder starts to take shape. The mood ranges from cautiously hopeful to optimistic. The price goes down again, but not as much as the head, which shows that people aren’t as eager to sell. The more bottomless low shows sellers are losing steam, and buyers are beginning to feel more confident. The mood starts to change from negative to positive.
At last, when the neckline breaks, confidence turns into bullishness. Most of the time, the price breaks above the neckline when there is more traffic. The break above the neckline confirms the bullish turnaround, which makes more traders waiting to enter the market come in. This often makes a big move-up happen.
In fundamental analysis, it’s essential to understand how traders think and feel. Studies in behavioral finance say cognitive biases like the representativeness heuristic and herd behavior can explain chart patterns like the inverted head and shoulders.
How to Use the Inverse Head and Shoulders Figure to Make Money
There are several essential steps to trading the inverted head and shoulders pattern, and each has its own set of things to consider. Here is a general idea of how to trade this chart pattern:
Name: Identification
The first thing the investor needs to do is find the Pattern on the chart. It has a left shoulder, a head, and a right shoulder. One thing to remember is that the Pattern should follow a decline. There has to be something to reverse for a turnaround to happen.
It’s official:
Neckline: Next, the investor should make a trendline that goes from the top of each shoulder to the top of the head.
Volume: Traders would look for more trades during the breakout above the neckline as a positive signal if volume data is available.
Get in:
Buy Signal: A trader could go long when the price breaks above the neckline, ideally on many trades, or when the price returns to test the neckline.
Dealing with risks:
Controlling Risks: To lower the chance of losing money, the trader should set a stop loss order just below the right shoulder or the neckline.
Position Sizing: The investor would also choose the trade’s size based on how much risk they are willing to take and how far away the entry point and stop loss are.
Profit Goal:
Target Price: The seller should find the target price by measuring the distance from the head’s top to the neck’s bottom. This amount will increase the length of the break at the collar.
Exit:
Take Profit: The trader should close the trade when the price hits the goal level or starts to go back up.
Trailing Stop: The trader could also use a trailing stop to make more money while keeping their account safe.
Other Things to Think About:
Indicators That Confirm: Traders would use technical indicators such as the RSI or MACD to get more proof of the inverted head and shoulders chart pattern.
Type of Time Frame: The trend on the chart is more likely to be accurate when the time frame is longer, like daily or weekly charts.
A Chart Pattern of an Inverse Head and Shoulders
The Invesco QQQ Trust Series (QQQ) showed the inverted head and shoulders pattern on a 15-minute chart from July 19 at 11:15 a.m. to August 24 at 10:00 a.m. This happened after it fell 8.57%, from a high point of $387.98 to a low point of $354.76.
Its right shoulder was marked by lower highs at $365.94 and $3263.03, with a low point at $360.68. When the price dropped to $354.70, the head became clear. After that, the ETF rose to a high point of $362.59, the top of the right shoulder. Its low point was $359.17.
Lower highs of $354.76 and $354.70 marked the important neckline. At 13:15 on August 21, QQQ broke above this neckline, setting a $370.66 goal for further gains. After reaching this goal, a gathering was held on August 24 at 9:30.
What Volume Means in the Inverse Head and Shoulders Chart Pattern Formation?
Volume is essential in proving a natural and robust inverted head and shoulders pattern.
The formation of the left shoulder usually causes volume to drop, which shows that selling pressure is easing. For the head of the inverse head and shoulders chart pattern, the volume may spike at the low point of the head as panic selling breaks out. However, the volume usually goes up again during the next rally, which shows that people are interested in buying again. The right shoulder generally has less volume than the head, so selling pressure is easing.
A significant rise in volume when the price breaks above the neckline during the breakout of the neckline is a strong positive signal. This means that everyone in the market agrees that the object will increase in value. If there was a lot of trading during the breakout, buyers are very committed to the uptrend, making it more likely to last.
Why is volume essential when making an inverse head and shoulders chart pattern?
In the case of an inverse head and shoulders chart design, volume is essential for more than one reason. Seeing that the chart pattern is still there is one reason. The trade signal is more likely to be accurate when there is a lot of movement, which proves that the Pattern is not a false breakout.
From the point of view of motion, volume is also essential. A breakout backed by volume usually means that the price will move faster and more robustly, making it easier to reach the profit goal.
Last but not least, volume can help you handle danger. Low volume during a breakout can be a red flag that the Pattern might not be as stable. This can help you determine how much risk you will take.
In technical analysis, volume is often considered an essential second factor after price. According to research in the field of market microstructure theory, volume tells us a lot about what traders think and plan, which makes it a valuable tool for verifying chart patterns.
Why are false breakouts essential in the inverse head and shoulders chart pattern?
In the case of the inverse head and shoulders pattern case, false breaks can significantly affect traders. When the price moves above the neckline but quickly goes back down, failing to keep going up, this is called a fake breakout.
Traders who go long based on the first breakout could lose money if the breakout is false. These fake peaks can make investors lose faith and make hasty choices, like selling too soon or not paying attention to stop loss levels.
A false breakout could also mean the asset is not yet ready for a bullish reversal, meaning the bearish opinion is still strong. Also, when a false breakout happens, it’s expected that you need to re-evaluate your trade strategy, including how you handle risk.
Some things you can do to lower the risk of false breakouts in the inverse head and shoulders chart pattern
If you do a few things, a false breakout is less likely to happen in the inverted head and shoulders chart pattern. One way is to check the volume. As a clear sign for the chart pattern we discussed, traders would look for many trades to happen when the neckline was broken.
Before making a trade, you can also wait for the price to close above the neckline and even test it again as support. In addition, traders would use trend analysis tools such as the RSI or MACD to get even more proof.
Once more, traders would set stop-loss orders to control their downside risk. This is especially important when trading on these kinds of pattern breaks.
How Important Is It to Test the Neckline in the Inverse Head and Shoulders Pattern?
In an inverse head and shoulders pattern, checking the neckline is a crucial step that can tell you much about how reliable the Pattern is and how the market feels about the asset.
When the price breaks above the neckline, it often goes back down to test the neckline as new support before moving up again. A good retest of the neckline adds to the evidence that the Pattern is correct and supports the idea of a bullish reversal.
Also, the retest gives traders who missed the first breakout a second chance to get in, usually with a smaller stop-loss order that lowers risk. The checking of the neckline also affects how the market feels. The fact that the previous resistance level (neckline) now acts as support after a successful retest shows that market opinion on the asset has changed from bearish to bullish.
Lastly, if the price falls below the neckline and fails to hold it, this could be a sign of a false breakout, which means the approach needs to be looked at again.
How to Make Money with the Inverse Head and Shoulders Pattern
In an inverted head and shoulders pattern, the distance between the neckline and the lowest point of the head is often used to set profit goals. This distance is called the price target, showing where prices might increase after the breakout.
The distance from the neckline to the lowest point of the head in the inverse head and shoulders pattern determines the profit goal. When the price breaks above the collar during the breakout, this distance is added to it.
Traders need to know the profit goal for this chart pattern. It helps determine the trade’s risk-reward ratio, which helps you make a choice. Traders can also take gains at a logical point, taking away some of the emotion of trading. To make the most money, the profit aim can also be aligned with other trading goals and strategies, like trailing stops.
When the inverse head and shoulders pattern is put together with technical analysis indicators,
Using other technical analysis indicators and the inverse head and shoulders Pattern, the trading signs will likely be more accurate. The following are some popular indicators that traders look at:
Averages that move:
The goal is to find the overall direction of the trend.
When a short-term moving average crosses over a long-term moving average, it can be a sign that the trend has turned positive.
RSI:
The goal is to find out if the market is high or oversold.
How to Use: An RSI number above 70 may show that the trend is going up, especially if it happens at the same time as the neckline breakout.
MACD:
The goal is to help you figure out movement and trend direction.
How to Use: A bullish MACD crossing can signify something is true.
Oscillator for volume:
The goal is to help prove how strong the trend is based on volume.
How to Use: An oscillator with a growing volume can confirm the breakout in the bullish direction, giving the Pattern more weight.
Using Fibonacci to trace:
The goal is to help find possible amounts of support and resistance.
How to Use It: The 50% or 61.8% retracement levels can be used as extra goals or confirmation points.
What are Bollinger Bands?
Goal: To find out about instability and possible changes in direction.
How to Use: The trend increases if the price rises and hits the upper Bollinger Band.
Oscillator of chance:
The goal is to help find situations where prices are too high or too low.
How to Use: A stochastic number above 80 usually shows an increasing trend.
What are some chart patterns used in technical analysis?
Technical analysis uses different chart patterns to look at how prices change and guess what the next trend will be. The head and shoulders, inner head and shoulders, the double top and double bottom, and the triple top and triple bottom are all pairs of patterns that can be turned around.
Flags, pennants, triangles, and rectangles are all examples of continuation designs. There are also momentum designs like the cup,dle, and wedges. Finally, the doji, the hammer or hanging man, and the bullish and bearish bursting patterns are all types of candlestick charts.
What assets can be used with the Inverse Head and Shoulder charts?
The inverse head and shoulders chart design is a valuable tool for many types of assets. Stocks, bonds, currencies, mutual funds, ETFs, options, futures, and real estate investment trusts (REITs) are a few of these.
When does the Inverse Head and Shoulders Pattern show up most often?
The trader’s financial goals will determine the best timeframe. Day traders might use hourly charts like the 1-minute, 5-minute, or 15-minute charts. Swing traders often use hourly charts. Most of the time, daily, weekly, or monthly periods are what position traders and long-term investors look at.
What technical analysis tools can be used with the Inverse Head and Shoulders Pattern?
Moving averages, the RSI, the MACD, the volume oscillator, Bollinger bands, and the stochastic oscillator are popular technical analysis indicators that can be used with the chart pattern above.
How Reliable Is the Head and Shoulders Pattern Backwards?
The inverse head and shoulders pattern isn’t always reliable. It depends on the product being traded, the market conditions, and the timeframe that is being used.
Conclusion
- An inverse head and shoulders pattern is like a standard head and shoulders pattern, but the design is backward.
- It can be used to guess when a decline will end.
- The market increases when an inverted head and shoulders pattern is finished.
- People who are investing usually take a long time when the price goes above the neckline’s resistance.
