Inverse Head And Shoulders Complete Guide

What is Inverse Head And Shoulders?

The Inverse Head and Shoulders is a premier bullish reversal pattern marking the transition from a downtrend to an uptrend. It consists of three distinct troughs: a 'Left Shoulder,' a deeper 'Head,' and a 'Right Shoulder' that is roughly level with the first. These troughs are separated by two intermediate peaks that define the 'Neckline' resistance level. According to Thomas Bulkowski’s research in the Encyclopedia of Chart Patterns, this formation is one of the most reliable and best-performing patterns, boasting a low failure rate of approximately 3% to 5% when a breakout occurs in a bull market. The formation begins as selling pressure creates the left shoulder, followed by a corrective bounce. A subsequent sell-off pushes prices to a new low (the head), but buyers return, pushing the price back to the neckline. The right shoulder forms when the price dips again but stays above the head's low, signaling waning bearish momentum. Volume is a critical confirming factor; typically, volume is highest on the left shoulder, diminishes during the head's formation, and should ideally surge during the breakout above the neckline. Bulkowski notes that the average rise following a confirmed breakout is approximately 38% to 45%, though performance varies based on the slope of the neckline and market conditions. Steve Nison also highlights this pattern in candlestick charting as a major trend reversal signal, often coinciding with bullish reversal candles at the troughs. Traders typically project a price target by measuring the vertical distance from the head to the neckline and adding it to the breakout point.

Identification Rules

1. The pattern must be preceded by a clear downtrend to be considered a reversal.
2. Three distinct troughs must be present, with the middle trough (head) being the lowest point.
3. The right shoulder's low must be higher than the head's low, indicating a shift in momentum.
4. A valid breakout requires a price close above the neckline, preferably accompanied by a surge in volume.

References

• Thomas N. Bulkowski (2005). Encyclopedia of Chart Patterns.
• Steve Nison (2001). Japanese Candlestick Charting Techniques.

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