How to identify and trade INVERSE HEAD and SHOULDERS Chart Pattern?
The Inverse Head-and-Shoulders is a widely recognized pattern used as a reversal signal, indicating a change in direction from a downward trend to an upward trend in price. This pattern is comprised of three troughs, or low points, which form the shape of a head and two shoulders.
As price drops to a low point and begins to recover, it encounters resistance and drops again. However, if the market is unable to support lower prices, the price rises once more, creating a higher low. The market resistance pushes the price back down again, resulting in the formation of the head, left shoulder, and right shoulder.
Two pullbacks occur during this pattern, one following the formation of the left shoulder, and the other after the head. These pullbacks are connected by a trendline known as the neckline or resistance line, which is extended to the right. The eventual breakout above this line is considered a confirmation of a reversal from a downward to an upward trend.
When the inverse head and shoulders pattern has formed, it signals a potential bottom in the market and it's a good time to consider entering long positions or buying. The pattern is considered complete once the price of the asset breaks above the neckline or resistance line.
Traditionally, a long position should be entered when the price moves above the neckline and a stop-loss order should be placed below the low point of the right shoulder.
If the two retracements in the pattern are similar in height or the second retracement is slightly lower than the first, then the neckline serves as a suitable entry point. However, if the right shoulder is higher than the first, the upward-slanting trendline won't provide a good entry point and it's better to enter a long position when the price moves above the high of the second retracement.
In situations where the neckline shows a gradual descent, it can be used as an entry point. However, if the neckline has a steep slope, either upward or downward, then it's better to use the high of the second retracement as the entry point.
Chart patterns can also provide approximate price targets based on the size of the pattern. This can be calculated by subtracting the low price of the head from the high price of the retracements, which will give you the height of the pattern.
It's important to note that the inverse head-and-shoulders pattern is not a guarantee of future price movements, and that other technical and fundamental factors should also be considered when making trading decisions.
