Head and Shoulders vs. Inverted Head and Shoulders

Patrick Meier
Feb 26, 2021
4 min read

Head and shoulders and inverted head and shoulders are both widely recognized chart patterns utilized in technical analysis to detect potential signals of bullish reversal in the stock market. These patterns emerge when an asset's price creates three peaks or valleys, with the middle peak or valley being the highest or lowest. This article will delve into the variances between head and shoulders and inverted head and shoulders, as well as which pattern indicates a bullish reversal.

Head & Shoulder vs Inverted Head & Shoulder — Photo from Canva Pro

Explanation of the Head and Shoulders Chart Pattern

The head and shoulders pattern is a technical chart formation that occurs when a security's price reaches a peak (the left shoulder), retraces, reaches a higher peak (the head), retraces again, and then reaches a third peak of similar height to the first (the right shoulder). The line connecting the lows of the retracements is known as the "neckline."

Breaking the neckline indicates a potential reversal in the trend. This pattern is widely recognized as a dependable signal of a trend reversal as it suggests a shift from bullish (buyers) to bearish (sellers) sentiment.

Recognizing the Head and Shoulders Pattern

To spot the head and shoulders pattern, you should search for the following key elements:

An initial peak (the left shoulder)
A retracement
A higher peak (the head)
Another retracement
A third peak of similar height to the first (the right shoulder)
A neckline linking the lows of the two retracements

Trading the Head and Shoulders Pattern

Once you have identified the head and shoulders pattern, you can execute trades by initiating a short position (selling) when the neckline is breached. Place your stop loss above the right shoulder and target a profit equal to the distance between the head and the neckline.

It is crucial to understand that the head and shoulders pattern does not always guarantee a reversal in trend. Sometimes, the neckline may be retested before a price decline, so it is vital to wait for confirmation before entering a trade.

Another trading strategy for the head and shoulders pattern is to wait for a retracement to the neckline post-breakout and then enter a short position. This method may offer a more favorable risk-to-reward ratio but requires patience.

Moreover, some traders utilize additional technical indicators to validate the head and shoulders pattern, such as volume, momentum, or oscillators. Elevated volume on the right shoulder compared to the left shoulder might suggest bearish dominance. Similarly, divergence in the momentum indicator or oscillator could indicate a potential reversal.

Understanding the Inverted Head and Shoulders Chart Pattern

The inverted head and shoulders pattern is essentially the opposite of the conventional head and shoulders pattern. It materializes when a security's price drops to a low (the left shoulder), rebounds, drops to an even lower low (the head), rebounds once more, and then falls to a third low akin in depth to the first (the right shoulder). The line connecting the peaks of the two rebounds forms the "neckline."

Breaking the neckline to the upside signifies a potential trend reversal. The inverted head and shoulders pattern is generally deemed a dependable reversal pattern as it indicates a shift from bearish to bullish control.

Recognition of the Inverted Head and Shoulders Pattern

In order to identify the inverted head and shoulders pattern, you should observe the following criteria:

An initial low (the left shoulder)

A rebound

A subsequent lower low (the head)

Another rebound

A third low that matches the depth of the first (the right shoulder)

A neckline that connects the peaks of the two rebounds

Utilizing the Inverted Head and Shoulders Pattern in Trading

Once you have recognized the inverted head and shoulders pattern, you can trade it by initiating a long position (buying) when the neckline breaks to the upside. Place your stop loss below the right shoulder and aim for a profit target equivalent to the distance between the head and the neckline.

Similar to the traditional head and shoulders pattern, the inverted head and shoulders pattern does not guarantee a trend reversal. At times, the neckline may be tested before the price ascends, so it is crucial to await confirmation before entering a trade.

Another method to trade the inverted head and shoulders pattern is to wait for a retracement to the neckline post-breakout before entering a long position. This strategy may offer a more favorable risk-to-reward ratio but necessitates patience.

Furthermore, some traders use additional technical indicators to validate the inverted head and shoulders pattern, such as volume, momentum, or oscillators. Higher volume on the right shoulder compared to the left shoulder can suggest bullish control. Likewise, divergence in the momentum indicator or oscillator can indicate a potential reversal.