An inverse head and shoulders pattern is a reversal chart pattern that signals a potential shift from a downtrend to an uptrend. The inverse head and shoulders pattern is also known as the reverse head and shoulders and looks like an inverted head and shoulders pattern.
Inverse head and shoulder was discovered by Charles Dow in the 1900s but was popularized in the 1930s by Richard Schabacker through his book, ‘Technical Analysis and Stock Market Profits.’
Inverted head and shoulders work by forming three troughs and two peaks consisting of a middle trough (head) with two higher troughs (shoulders) on either side. The head is deeper than the left and right shoulders, and a neckline connects the highs of the shoulders using a horizontal or slightly sloping line. Breakouts above the neckline signal a potential bullish reversal.
Traders use the inverse head and shoulders pattern in Forex trading by identifying the pattern, confirming the pattern, executing trades, setting stop-loss and take-profit orders, and evaluating the trades.
The benefits of using inverse head and shoulders patterns in Forex trading include a clear bullish signal, defined entry and exit points, high accuracy and success rate, volume confirmation, and easy combination with indicators.
The downsides of using inverse head and shoulders patterns in Forex trading include false breakouts, difficulty in identification, late signals, emotional trading, and market volatility.
What is an Inverse Head and Shoulders Pattern?
An inverse head and shoulders pattern is a reversal chart pattern that occurs at the end of a downtrend and signals a potential shift in market sentiment from bearish to bullish. The inverse head and shoulders pattern features three successive price troughs that resemble the shape of an inverted human head with the left and right shoulders.
The left shoulder of an inverse head and shoulders pattern forms after a sustained downtrend when the price forms a lower low, followed by a rally to form the first trough. The head of a head and shoulders pattern forms when the price declines to form the lowest point in the pattern, then rallies back up, forming the second trough.
The right shoulder of an inverse head and shoulders pattern forms when the price attempts to resume the downtrend but fails to reach the level of the head and rallies up, forming the third trough. Traders connect the peaks of the left shoulder and right shoulder with a straight line, creating a neckline that serves as a resistance level. A break above the neckline confirms the trend reversal from bearish to bullish.
Inverse head and shoulders meaning in trading is that selling pressure is weakening as buyers gain more control, causing a shift in market sentiment. Inverse head and shoulders pattern in Forex and the stock markets signals traders to exit their short positions and open long positions once the price breaks above the neckline.
The inverse head and shoulders pattern is among the basic Forex terms used by beginners when exploring technical chart patterns.
What is the history of Inverse Head and Shoulders?
The inverse head and shoulders pattern was developed by Charles Dow in the 1900s when he spotted the head and shoulders pattern in the stock market. The inverse head and shoulders pattern was popularized among traders in the 1930s by Richard Schabacker through his book, ‘Technical Analysis and Stock Market Profits’, and more recently in 1985 by technical analyst John Murphy in his book ‘Technical Analysis of the Financial Markets.’
The inverse head and shoulder was discovered as a mirror image of the head and shoulders market. The main goal of developing the inverse head and shoulders pattern was to help traders identify potential trend reversals in bearish markets by providing early indications of the shift in market sentiment.
Traders have modified the inverse head and shoulders pattern over the years to improve their decision-making in trading and enhance their risk management when markets bottom out and new trends emerge. The inverse head and shoulders pattern has been adopted in the analysis of different financial instruments, including currencies, commodities, and cryptocurrencies.
The rules for the formation of a valid inverse head and shoulders pattern differ slightly depending on the trader, but the foundational supply and demand principles remain the same.
How does the Inverse Head and Shoulders Pattern work?
The inverse head and shoulders pattern works as a bullish reversal pattern, indicating the end of a downtrend and a shift to an uptrend. Inverse head and shoulders pattern shows the point in the market where supply and demand shifts as buyers overpower sellers to take control of the market.
The formation of an inverse head and shoulders pattern follows four rules. First, the asset or security’s price should be in a prolonged downtrend. Second, the visual representation of the inverse head and shoulder pattern should include a series of three troughs (lows), with the middle trough (head) being the lowest. Third, the two outer troughs (left and right shoulders) should be higher than the middle trough. Finally, the price must break above the neckline formed by the highs of the two outer troughs (shoulders).
The left shoulder of the inverse head and shoulder forms when the price is in a clear downtrend, signifying that supply is higher than demand. A temporary rally begins when buyers enter the market because they find the lower prices attractive, completing the first trough and forming the peak of the left shoulder.
The head forms when sellers regain control of the market, and the price pushes lower to form a new low, creating the head and completing the lower highs, lower lows pattern. The head becomes the point of maximum selling pressure where most inexperienced traders take panic sells without regard for the sentiment shift. Demand increases significantly in the middle trough as more buyers see lower prices as an entry opportunity, resulting in a stronger rally than on the left shoulder.
The right shoulder forms when sellers attempt to regain market control by pushing markets lower, but they fail, and the price dip forms a higher low than the head, signaling a weakening supply as selling pressure reduces and demand strengthens. Buyers step into the market aggressively, intensifying buying pressure and resulting in a sentiment shift where demand is higher than supply, pushing prices to form new highs. Some traders, including institutional traders and experienced investors, accumulate positions during the formation of the right shoulder as they anticipate a trend reversal.
An inverse head and shoulders pattern is complete when a neckline is drawn connecting the peaks of the left shoulder and head, representing a resistance level where sellers managed to hold twice. Traders determine when buying pressure increases and overcomes supply when the price breaks and closes above the neckline.
What is an Inverse Head and Shoulders Pattern Target?
The profit target for the inverse head and shoulders pattern is the height of the pattern or the vertical distance between the lowest point of the head and the neckline. Traders project the height of the inverse head and shoulders pattern from the breakout point, forming the target price.
The formula for calculating the target price for the inverse head and shoulders pattern is Target Price = Neckline Breakout Level + (Neckline Level − Head Low).
Other traders determine the target of the inverse head and shoulders pattern by analyzing historical price movements after breaking out from the neckline to determine the average price movement. For instance, a Forex EUR/USD trader may backtest and find that the price moves around 50 pips after breaking out of the inverse head and shoulders pattern on the H1 timeframe. The trader’s target price when trading the inverse head and shoulders pattern will be 50 pips from the neckline every time the pattern appears on the chart.
Fibonacci traders use the retracement and extension levels as the target for the inverse head and shoulders patterns. The traders draw the Fibonacci retracement tool from the highest point of the pattern to the lowest point of the head and then project the target to one of the retracement targets, e.g., 38.2%, 50.0%, 61.8%, and 78.6%. Fibonacci extension levels like 127.2%, 161.8%, and 261.8% enable traders to move the price targets higher if the bullish reversal experiences higher momentum, enabling them to secure higher profits.
The inverse head and shoulders stop-loss target is usually placed below the head low or the right shoulder low.
Is Volume Significant for Inverse Head and Shoulder Formation?
Yes, volume is significant for the formation of the inverse head and shoulders pattern. Volume acts as the confirmation for the bullish reversal signal once price breakouts of the inverse head and shoulders neckline. Large volume spikes during breakouts indicate strong buying pressure and greater potential for prices to continue rising higher.
Volume decreases during the formation of the left and right shoulders and increases when the head forms. Valid inverse head and shoulders patterns are characterized by significant increases in volume on the breakout above the neckline and a sustained increase as the price moves higher to form higher highs and higher lows.
An increase in volume during the formation of the inverse head and shoulders pattern increases the reliability of the pattern and helps traders avoid false breakouts where the price reverses quickly and fails to continue upward. Traders interpret high volume as the hand of institutional players and other big market players supporting the bearish to bullish trend reversal.
Is the Inverse Head and Shoulders Pattern a common Chart Pattern?
Yes, the inverse head and shoulders pattern is a common chart pattern. Traders spot the inverse head and shoulders pattern across various asset classes, including major and minor Forex pairs, stocks, commodities, and cryptocurrencies, as bearish trends bottom out. The inverse head and shoulders pattern has a clear structure, making it easy to recognize, even for novice traders.
Inverse head and shoulders is versatile across timeframes, making it popular among intraday and long-term traders. Scalpers and day traders identify the inverse head and shoulders pattern on relatively short timeframes like M15, M30, and H1, while swing traders exploit the pattern on high timeframes like H4, daily, and weekly to capture large moves.
Traders prefer the head and shoulder pattern over other types of chart patterns because it provides well-defined entry and exit points. Confirming the inverse head and shoulders pattern using volume makes it easier for traders to avoid false signals, resulting in a higher success rate and attracting more traders to the formation.
How to use an Inverse Head and Shoulders Pattern in Forex Trading?
Here is how to use the Inverse Head and Shoulders Pattern in Forex Trading:
- Identify the pattern. Look for a series of three lows, with the middle low (the head) being lower than the other two (the shoulders), to identify an Inverse Head and shoulders pattern. The lows are typically separated by two higher lows. This formation resembles the shape of a head and two shoulders.
- Draw a neckline: Connect the peaks (highs) of the left shoulder and the head using a horizontal line to form the neckline. Some necklines are sloped slightly when demand is higher during the formation of the right shoulder in an Inverse Head and Shoulders pattern.
- Confirm the pattern. Wait for a confirmation of the formation. Confirmation signals of an Inverse Head and Shoulders Pattern can include seeing a price breakout and close above the neckline or increased volume accompanying the breakout to indicate strong buying pressure. Traders use other indicators like moving averages, RSI, or MACD to further confirm bullish signals in an Inverse Head and Shoulders pattern.
- Execute the trade: Open a long position when the price breaks above the neckline with confirmation of the Inverse Head and Shoulders pattern from volume and other indicators. Limit traders place pending buy orders above the neckline to catch the breakout.
- Set stop-loss: Place a stop-loss order below the lows of the right shoulder or the head in the Inverse Head and Shoulders Pattern. Swing traders place stop-loss orders below the head of the pattern, giving the market enough room to survive market fluctuations.
- Place take-profit level: Measure the distance from the head to the neckline of the Inverse Head and Shoulders pattern. Add the distance to the breakout point at the neckline to set a clear profit target.
- Evaluate and learn: Analyze each trade’s performance to understand what worked well and what could be improved. Use insights gained from the trades to refine Inverse Head and Shoulders Pattern recognition skills, adjust the trading strategy, and improve future trading decisions.
How to Identify the Inverse Head and Shoulders Chart Pattern?
To identify the inverse head and shoulders pattern, look for downtrends in the currency pair or stock being analyzed and identify the four components of the pattern, including the left shoulder, head, right shoulder, and neckline. Ensure the left shoulder and right shoulder are relatively equal in height and that the head is lower than both shoulders. Look for a clear neckline with a noticeable slope and confirm that the price has broken above the neckline with a distinct breakout.
Traders identify the inverse head and shoulders chart pattern in established down-trending markets that are in a prolonged bearish trend. The traders look for clear and well-defined lower highs and lower lows as the pattern begins to take shape.
Valid inverse head and shoulders patterns consist of four components that define its shape, the left shoulder, head, right shoulder, and neckline. Ensure the left and right shoulders form by price declining and rebounding, creating two lows, with the head forming the lowest low in the formation.
Draw a neckline by connecting the peaks of the left and head or right shoulder to confirm the complete pattern. The inverse head and shoulders neckline can be straight or have a noticeable slope to represent the shifting market sentiment. The best neckline has price bouncing off the level a few times before breakout, confirming its role as a resistance level.
Traders identify a complete inverse head and shoulders pattern by validating that the price has broken out above the neckline with a clear and distinct breakout. Look for increasing volume on the breakout and a re-test of the neckline with price bouncing off it.
Use other indicators like the moving average to verify the pattern’s bullish signal when the price crosses above the indicator. Confirm the bullish signal from inverse head and shoulders pattern by looking at oscillators like RSI and MACD to see if the market is oversold.
Is the Inverse Head and Shoulders Pattern bullish?
Yes, the inverse head and shoulders pattern is bullish. Inverse head and shoulders patterns form at the end of a downtrend and indicate a potential bullish trend reversal. The inverse head and shoulders pattern shows a period of selling exhaustion in markets and buyers aggressively taking advantage of the lower prices, increasing the buying pressure and pushing prices up.
Traders confirm the bullish signal in markets when the price breaks above the neckline, accompanied by an increase in volume. Sellers attempt to push prices lower and maintain the bearish momentum once the head of the inverse head and shoulders pattern is formed, but the attempt fails as buyers dominate sellers, leading to a strong bullish reaction or a short squeeze that drives prices higher.
The inverse head and shoulders pattern breaks out of the neckline to the upside around 98% and to the downside, just 2% of the time, proving that it is very bullish, according to Thomas Bulkowski’s research in the book ’Encyclopedia of Chart Patterns.’
Is Identifying Inverse Head and Shoulder with Forex Broker easier?
Yes, identifying inverse head and shoulders is easier with Forex brokers. Traders use drawing and charting tools provided by Forex brokers like horizontal, vertical, and trend lines to identify the three bottoms (left shoulder, head, and right shoulder) after a bearish trend, draw a valid neckline, and confirm volume using indicators.
Forex brokers provide regular education about chart patterns like the inverse head and shoulders pattern, making it easier for new traders to understand the pattern’s structure and spot it in any currency market. Some brokers provide alerts when the pattern is forming, reducing the issue of subjectivity among traders and improving the traders’ pattern recognition skills.
Traders gain access to a ton of historical data for backtesting provided by their Forex broker, enabling them to study past formations of the inverse head and shoulders pattern and gain insights into how it behaves in different market conditions. Some of the best Forex broker platforms offer automatic pattern recognition software, ensuring traders do not need to identify the inverse head and shoulders pattern manually.
The Forex broker meaning and goal is to simplify the trader’s pattern recognition process so they can take more trades with precision.
When do Forex Traders use the Inverse Head and Shoulders Pattern?
The Inverse Head and Shoulders pattern is typically used in Forex trading when traders are anticipating a trend reversal from a downtrend to an uptrend. Forex traders use inverse head and shoulders patterns when looking for buying opportunities at the start of new bullish trends and when looking for counter-trend moves in bearish markets on lower timeframes.
Forex traders use the inverse head and shoulders pattern when markets are approaching a significant resistance zone that could trigger a trend reversal. Traders look for the formation of the inverse head and shoulders pattern to signify a weakening bearish momentum and a potential shift from a bearish trend to a bullish trend.
Short-term traders like scalpers and day traders use the inverse head and shoulder pattern to identify buying opportunities when the market is still in consolidation, preparing for a breakout. Aggressive Forex traders do not wait for the inverse and head and shoulders pattern to complete, but they place trades while the right shoulder is still forming to get sniper entries.
Counter-traders use the inverse head and shoulders pattern when looking to execute trades in markets that are still in long-term bearish trends. The counter traders seek to capitalize on bullish trend corrections by identifying the inverse head and shoulders pattern on lower timeframes like the M30 or H1 and placing buy trades against the overall trend, profiting from retracement.
Inverse head and shoulders pattern is better used when traders see volume confirmation that the pattern’s formation is complete. The real Forex trader definition is tested by whether the trader can wait for the inverse head and shoulder pattern to complete before placing trades.
What is the effectiveness of the Inverse Head and Shoulder in Trading?
The success rate of the inverse head and shoulders pattern stands at around 85%. The inverse head and shoulders pattern has a 74% success rate in predicting a successful bullish reversal if the breakout is accompanied by high volume and reduces to 26% without volume confirmation, according to Thomas Bulkowski’s book ‘Encyclopedia of Chart Patterns.’
The effectiveness of the inverse head and shoulder pattern in trading is affected by the trader’s skill and experience, market conditions, and the use of confirmation before placing trades. The effectiveness of the inverse head and shoulders pattern is highest among traders who regularly backtest the pattern using historical data.
The inverse head and shoulder pattern follows a clear structure in its visual representation, making it easy to identify and utilize for profit-making. Traders who misidentify the pattern by confusing it with the cup and handle pattern or a double bottom chart may experience a lower success rate using the pattern. Studying the historical performance of the inverse head and shoulders makes it easier for traders to spot the pattern quickly, improving its effectiveness.
Inverse head and shoulders pattern is more effective in volatile markets because of the quick price movement. Traders experience more success trading the major currency pairs because of their high trading volume, resulting in a quicker formation of the inverse head and shoulders pattern, which is better for intraday traders.
The inverse head and shoulders pattern is more effective when combined with other indicators like the Fibonacci levels, volume indicators like On-Balance Volume (OBV), and technical oscillators like RSI and MACD. Adding indicators to the trading strategy provides extra confirmation of the sentiment shift and helps traders filter out false signals.
The effectiveness of the inverse head and shoulders pattern is reduced for traders who ignore proper risk management techniques like setting stop-loss orders and position sizing.
The inverse head and shoulders pattern is efficient and accurate when traders stick to their trading plan and observe strict risk management.
What is the accuracy of the Inverse Head and Shoulders pattern?
The accuracy of the inverse head and shoulders pattern varies depending on the market volatility, the pattern’s symmetry, and the lookback period during backtesting. The inverse head and shoulder pattern is one of the most accurate chart patterns, with an accuracy of about 98%, according to Thomas Bulkowski in the book ‘Encyclopedia of Chart Patterns.’
Bulkowski’s research indicates that the inverse head and shoulder pattern has a 74% accuracy of price reaching its target once the neckline is broken. The book records that the inverse head and shoulders pattern has a 52% accuracy if the price pulls back to the neckline or support zone before reaching the target.
Traders experience a higher accuracy in trading the inverse head and shoulders pattern in fast-moving markets. The accuracy of the inverse head and shoulders pattern increases if the price consolidates for a long period before breaking out of the neckline. Forex traders achieve higher accuracy if the inverse head and shoulders pattern has a downward-sloping neckline, where the left shoulder is higher than the right shoulder.
The accuracy of the inverse head and shoulders pattern is higher for traders who use a longer lookback period when backtesting, resulting in a larger sample size and higher quality results.
Is Inverse Head and Shoulders Pattern Reliable?
Yes, the inverse head and shoulders pattern is reliable. The inverse head and shoulders pattern forms frequently across chart patterns and is highly accurate in predicting potential trend reversals. Traders receive clear entry and exit points using the inverse head and shoulders pattern, making it ideal for all trading strategies.
The inverse head and shoulders pattern appears in all Forex charts from major Forex pairs like USD/JPY, EUR/USD, and GBP/USD, to minor pairs like EUR/JPY and GBP/JPY, and exotic currency pairs like EUR/ZAR, and SEK/JPY. Inverse head and shoulders patterns are easy to identify and confirm using volume on all timeframes.
The inverse head and shoulders pattern offers traders clear entry and exit points with well-defined price levels for setting stop-loss orders and measuring the target price. Beginner Forex traders rely on the inverse head and shoulders pattern to place positions and secure profits, making it a reliable chart pattern for trading.
What happens when Inverse Head and Shoulders fail?
When an inverse head and shoulders pattern fails, it means the price has failed to break out of the neckline, and consolidation continues. A failed inverse head and shoulders pattern indicates a continuation of the prevailing downtrend as sellers regain control of the market and increase selling pressure, pushing prices lower. The failure rate of the inverse head and shoulders pattern is around 2%, according to the ‘Encyclopedia of Chart Patterns’ by Thomas Bukowski.
When an inverse head and shoulder fails, the price is likely to decline and form a lower low, beating the low formed by the head and invalidating the setup. Buyers are squeezed out of the market when the inverse head and shoulders fails, and the demand for the asset, like a currency pair, drops.
A false breakout may occur when an inverse head and shoulders pattern fails. The false breakout forms when the price breaks out above the neckline but fails to sustain the bullish pressure and falls back below the neckline. Whipsaws may arise in the market as price takes out stop-loss orders placed below the neckline, resulting in high market volatility.
Traders who enter long positions experience losses when the inverse head and shoulders pattern fails.
What are the Benefits of Using Inverse Head and Shoulders Patterns in Forex Trading?
The benefits of using inverse head and shoulders patterns in Forex trading are listed below.
- Clear bullish reversal signal: Inverse head and shoulders pattern provides an early indication of a potential end to a downtrend and the beginning of an uptrend.
- Defined entry and exit points: Inverse head and shoulders pattern offers clear entry points above the break of the neckline and exit points at the project height of the pattern from the breakout point.
- High accuracy and success rate: Inverse head and shoulders pattern has a high accuracy in predicting trend reversals, with technical analysts like Thomas Bukowski placing its success rate at around 85%.
- Volume confirmation: Inverse head and shoulders pattern is easy to validate and confirm with volume, increasing its effectiveness during breakouts.
- Combination with indicators: Inverse head and shoulders pattern integrates with other indicators like RSI, Moving Averages, and MACD, enhancing the reliability of different trading strategies.
What are the Downsides of using the Inverse Head and Shoulder in Forex trading?
The downsides of using head and shoulders patterns in Forex trading are listed below.
- False breakouts: Inverse head and shoulders pattern experiences false signals, especially on lower timeframes, leading to losses for intraday traders.
- Difficulty in identification: Beginners often misinterpret the inverse head and shoulder pattern because it appears similar to other formations, resulting in poor trading decisions.
- Late signals: Traders receive entry signals late as they wait for the inverse head and shoulders pattern confirmation, which may form after a considerable portion of the uptrend has formed.
- Emotional trading: Aggressive traders rush into traders before the right shoulder is complete and the volume confirmed, increasing their risk exposure and resulting in substantial losses if the inverse head and shoulders pattern fails.
- Market volatility: Inverse head and shoulders pattern formation is affected by high volatility, resulting in sudden price swings that invalidate the setup or lead to premature stop-outs.
Is Inverse Head and Shoulder better than Cup and Handle?
No, the inverse head and shoulder pattern is not better than the cup and handle pattern. The inverse head and shoulders pattern appears at the end of a downtrend and is ideal for traders anticipating bullish reversals, while the cup and handle pattern is ideal for traders looking for continuations within an uptrend.
The inverse head and shoulders pattern takes a relatively short time to form, making it ideal for intraday traders to exploit opportunities in lower timeframes. The cup and handle pattern takes a long time to form due to its long consolidation phase, making it ideal for swing traders looking for opportunities on higher chart timeframes. According to Thomas Bukowski’s book ‘Encyclopedia of Chart Patterns,’ the inverse head and shoulder formation takes an average of 73 days (2.5 months), while the cup and handle pattern formation takes around 208 days (7 months) on the daily timeframe.
The inverse head and shoulders pattern is typically easier to identify than the cup and handle pattern because it has a better-defined structure. Determining the rounded parts of the cup and handle pattern is often difficult for inexperienced traders, making the pattern better suited for experienced traders and investors.
The choice between the inverse head and shoulders pattern and the cup and handle pattern depends on the trader’s strategy and risk tolerance.
What is the difference between Inverse Head and Shoulders and Head and Shoulders Pattern?
The difference between the “inverse head and shoulders pattern” and the “head and shoulders pattern” lies in where they form on price charts and their directional bias. The inverse head and shoulders pattern and the head and shoulder pattern both feature three price peaks, with the middle peak or trough (head) being higher or lower than the two shoulders.
The inverse head and shoulders pattern forms at the end of a downtrend and signals a potential bullish reversal, while the head and shoulders pattern forms at the top of an uptrend, indicating a potential bearish reversal.
Traders open sell orders when price breaks below the neckline of the head and shoulders pattern and buy orders when price breaks above the neckline of the inverse head and shoulder pattern.