Inverse head and shoulders pattern

An inverse head and shoulders pattern is a bullish reversal formation. Price makes a low and bounces, makes a lower low and bounces to roughly the same area, then falls a third time and stops above the previous low. The trend has stopped making lower lows.

It is the mirror image of the head and shoulders pattern. Other names for it are inverted head and shoulders and head and shoulders bottom.

• Prior downtrend – there should be a clear decline into the left shoulder. The pattern needs a fall to reverse.
• Left shoulder – a low in the downtrend, followed by a bounce.
• Head – a decline to a lower low, then a rally back to the area of the first bounce.
• Right shoulder – a third decline that stops above the head, often near the level of the left shoulder.
• Neckline – the line through the two highs between the lows. It can be flat or sloped, and it acts as resistance until it breaks.
• Confirmation – a candle that closes above the neckline. Until then the pattern is not complete.
• Practice – mark the neckline with a trend line on Charts and step through past bottoms in Replay.

Volume matters more at bottoms than at tops. A market can fall under its own weight, but it takes buying to push it up.

In the classic description volume is heavy on the left shoulder, lighter on the head, and picks up on the rally from the head. Traders want to see a clear rise in volume on the close above the neckline. A breakout on thin volume is treated with more caution.

The trade is a long, taken after the neckline breaks.

• Entry – on the close above the neckline, or on a retest of the neckline from above. Retests are common, but not every breakout gives one.
• Stop – below the right shoulder. Traders who enter on a retest often place it just below the neckline: the stop is tighter and is hit more often.
• Target – the measured target: the vertical distance from the bottom of the head to the neckline, projected up from the point of the breakout.
• Position size – set it from the distance to the stop, not from the distance to the target.

A market falls to 119, bounces to 132, falls to 103, rallies back to 132 and then dips to 120. The neckline is at 132 and the head is 29 points below it. A close above 132 gives a measured target of 132 + 29 = 161.

The target is an estimate of the size of the move, not a level price has to reach. Earlier highs from the downtrend sit on the way up, and many traders close part of the position there.

• Where it forms – the inverse pattern after a downtrend, the regular one after an uptrend.
• Shape – three lows with the deepest in the middle against three peaks with the highest in the middle.
• Neckline – drawn through the highs between the lows against the lows between the peaks.
• Signal – a close above the neckline is bullish; a close below it is bearish.
• Volume – traders ask for rising volume on an upside breakout. A downside break is accepted with less.

• Buying the right shoulder before the breakout – in a downtrend many patterns never complete, and the right shoulder becomes one more lower high.
• Calling any three lows a pattern – without a prior decline and a head that stands out it is a range.
• Ignoring the higher timeframe – a small bottom on a 15-minute chart inside a daily downtrend often gives only a short bounce.
• Holding a failed pattern – if price closes back below the neckline and then below the right shoulder, the pattern has failed.
• Chasing a long breakout candle – the entry ends up far from the stop. A retest of the neckline gives a better price, when it comes.