Understanding the inverse head and shoulders meaning and chart pattern may seem very convoluted at the beginning. Still, it helps novice and even advanced traders understand the market and speculate based on logic. Most traders seek from this chart pattern the defined areas that allow anyone to set stop losses and maximize profits specifically.
But, are they reliable to spot trend reversals? Here’s what you must understand and learn how to apply them to predict a bearish to bullish trend reversal critically.
Inverse Head and Shoulders Meaning
As the name suggests, this is the opposite of the head and shoulders – and as such, it indicates a bullish reversal. An inverse head and shoulders is formed when the price falls to a lower low in a downtrend, then bounces and finds support at roughly the same level as the first low. The pattern is confirmed once the price breaches the neckline resistance and continues higher.
A suitable profit target can be ascertained by measuring the distance between the bottom of the head and the neckline of the pattern and using that same distance to project how far the price may move in the direction of the breakout.
For example, if the distance between the head and neckline is ten points, the profit target is set ten points above the pattern's neckline. An aggressive stop-loss order can be placed below the breakout price bar or candle. Alternatively, a conservative stop-loss order can be placed below the right shoulder of the inverse head and shoulders pattern.
What Is The Neckline in an Inverse Head and Shoulders?
The neckline is the level of support used to determine where to place orders. To identify the neckline, first locate the left shoulder, head, and right shoulder on the chart. In the inverse head and shoulders pattern (market bottom), we connect the high after the left shoulder with the high created after the head.
What Does an Inverse Head and Shoulders Indicate?
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.
However, once the price rises a second time and reaches a point above the initial peak, it is clear that bulls are gaining ground. Bears try one more time to push the price downward but succeed only in hitting the lesser lower reached in the initial trough. This failure to surpass the lowest low signals the bears' defeat and bulls take over, driving the price upward and completing the reversal.
Identifying the Inverse Head and Shoulders
An inverse head and shoulders pattern is comprised of three component parts:
1. After long bearish trends, the price falls to a trough and subsequently rises to form a peak.
2. The price falls again to form a second trough substantially below the initial low and rises yet again.
3. The price falls for a third time, but only to the level of the first trough, before rising once more and reversing the trend.
How Should One Trade 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.
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.
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.
Closing Thoughts
To recap, the inverse head and shoulders are one of the most popular and lucrative chart patterns. Still, you should be ready for failures, especially given that trading can incur losses in addition to cryptocurrencies being volatile and unpredictable.
All in all, we hope that you’ll enjoy trading this pattern now that you’ve understood inverse head and shoulders meaning. For beginner traders, it would make sense to first start by trying to identify the pattern in historical charts and practice trading them on demo accounts.
