The inverse head and shoulders pattern is a technical chart pattern used by traders and analysts to predict bullish reversals in the price of an asset. It is the opposite of the well-known head and shoulders pattern, which signifies a bearish reversal. Understanding how to identify and interpret the inverse head and shoulders pattern can be valuable for traders looking to capitalize on potential upward price movements.
Identifying the Pattern
To identify an inverse head and shoulders pattern, traders look for three main components: a left shoulder, a head, and a right shoulder. These components form a pattern that resembles the silhouette of a head and two shoulders when plotted on a price chart. The left shoulder and the head create a temporary downtrend, while the head and the right shoulder form a base and indicate a potential reversal of the downtrend.
Components of the Pattern
- Left Shoulder: The left shoulder occurs when the price of an asset declines from its peak and then rebounds slightly. This rebound forms the left shoulder of the pattern and represents the first phase of the temporary downtrend.
- Head: Following the left shoulder, the price of the asset falls further, reaching a new low before experiencing a significant upward movement. This upward movement creates the head of the pattern, which is typically lower than the left shoulder. The head signifies increased selling pressure followed by a strong buying response.
- Right Shoulder: After the formation of the head, the price of the asset retraces again but fails to reach the lows seen during the formation of the head. This retracement forms the right shoulder of the pattern, completing the temporary downtrend. The right shoulder is typically higher than the head, indicating diminishing selling pressure and a potential shift in sentiment.
Neckline
The neckline of the inverse head and shoulders pattern is a trendline drawn across the peaks of the left shoulder, head, and right shoulder. It serves as a level of resistance that the price must break above to confirm the pattern. Once the price surpasses the neckline, it is considered a bullish signal, indicating that the downtrend may be reversing and that a new uptrend could be beginning.
Volume
Volume is an important factor to consider when analyzing the inverse head and shoulders pattern. Ideally, volume should decrease as the pattern develops, signaling weakening selling pressure. When the price breaks above the neckline, confirming the pattern, volume should ideally increase, indicating strong buying interest and further supporting the bullish reversal.
Price Target
To determine a price target for the inverse head and shoulders pattern, traders often measure the distance from the neckline to the lowest point of the head and then add that distance to the breakout point above the neckline. This provides an estimate of how far the price could potentially rise following the pattern confirmation.
