The inverse head and shoulders is one of the most reliable bullish reversal patterns in technical analysis. When you spot this pattern forming at the bottom of a downtrend, it often signals that the selling pressure is exhausted and buyers are about to take control. In this comprehensive guide, we will teach you everything you need to know about trading this powerful pattern.
What is an Inverse Head and Shoulders Pattern?
An inverse head and shoulders, also called a head and shoulders bottom, is a chart pattern that forms after a downtrend. It consists of three troughs: a left shoulder, a deeper head in the middle, and a right shoulder that is roughly equal to the left shoulder. The pattern is completed when price breaks above the neckline, which connects the highs between the shoulders and head.
Key insight: The inverse head and shoulders shows that sellers tried three times to push prices lower, but each attempt resulted in less selling pressure. This exhaustion of selling is what makes it such a powerful reversal signal.
The Anatomy of the Pattern
Understanding each component helps you identify the pattern correctly:
1. The Left Shoulder
The left shoulder forms when price drops to a new low during the downtrend, then bounces back up. This creates the first trough. Volume is typically high during this decline as selling pressure is still strong.
2. The Head
After the bounce from the left shoulder, price drops again and makes an even lower low. This is the head of the pattern and represents the final push by sellers. Volume is usually lower than the left shoulder, showing weakening selling interest.
3. The Right Shoulder
Price bounces from the head and then drops again, but this time it cannot reach the depth of the head. The right shoulder forms at approximately the same level as the left shoulder. Volume is typically the lowest of all three troughs, confirming seller exhaustion.
4. The Neckline
The neckline is drawn by connecting the highs between the left shoulder and head, and between the head and right shoulder. This line acts as resistance that must be broken to confirm the pattern.
How to Confirm the Pattern
Not every inverse head and shoulders leads to a successful trade. Here is how to confirm the pattern is valid:
- Prior downtrend: The pattern must form after a clear downtrend. Without a preceding decline, there is nothing to reverse
- Symmetry: The shoulders should be roughly equal in depth and duration. Perfect symmetry is not required, but they should be close
- Volume pattern: Ideally, volume decreases from left shoulder to head to right shoulder, then increases on the neckline breakout
- Neckline break: The pattern is not complete until price closes above the neckline with conviction
Example Trade Setup
Stock XYZ has been in a downtrend from $80 to $50 over three months.
- Left shoulder forms at $52, bounces to $58
- Head forms at $48, bounces to $57
- Right shoulder forms at $51, approaches $57 neckline
- Price breaks above $57 neckline on high volume
- Entry: $57.50 (after breakout confirmation)
- Stop loss: $50 (below right shoulder)
- Target: $66 ($57 + $9 pattern height)
Calculating the Price Target
The measured move technique gives you a reliable price target:
- Measure the distance from the head to the neckline (the pattern height)
- Add this distance to the neckline breakout point
- This gives you the minimum expected move
For example, if the head is at $48 and the neckline is at $57, the pattern height is $9. Adding $9 to the $57 breakout gives a price target of $66.
Entry Strategies
There are several ways to enter an inverse head and shoulders trade:
Aggressive Entry
Enter as soon as price breaks above the neckline. This gives you the best price but comes with higher risk of false breakouts.
Conservative Entry
Wait for a daily close above the neckline, then enter on the next day open. This confirmation reduces false signals but may result in a worse entry price.
Pullback Entry
After the initial breakout, price often pulls back to test the neckline as support. Entering on this retest can provide an excellent risk-reward ratio, but not all breakouts pull back.
Setting Your Stop Loss
Place your stop loss at one of these levels:
- Below the right shoulder: Most common placement, gives the trade room to work
- Below the neckline: Tighter stop for aggressive traders, higher risk of being stopped out
- Below the head: Very wide stop, only for position traders with long time horizons
Common Mistakes to Avoid
Even experienced traders make these errors with the inverse head and shoulders:
- Trading before confirmation: Do not enter until the neckline breaks. Many patterns fail before completion
- Ignoring volume: A breakout on low volume is more likely to fail. Look for volume expansion
- Forcing the pattern: If you have to squint to see it, it probably is not there
- Wrong timeframe: Patterns on higher timeframes (daily, weekly) are more reliable than intraday patterns
- Ignoring the trend: If the broader market is in a strong downtrend, reversal patterns are less likely to work
Volume Analysis
Volume tells you the conviction behind price moves:
- Left shoulder: High volume during the decline shows strong selling
- Head: Volume should be lower than the left shoulder, indicating weakening sellers
- Right shoulder: Lowest volume of the three troughs, confirming seller exhaustion
- Breakout: Volume should expand significantly above the neckline
Combining with Other Indicators
Increase your success rate by confirming with other tools:
- RSI divergence: Bullish divergence (price makes lower lows, RSI makes higher lows) during the pattern formation strengthens the signal
- Moving averages: A breakout above the 50-day or 200-day moving average adds confidence
- Support levels: If the pattern forms at a major historical support level, the reversal is more likely
Track Your Chart Pattern Trades
Pro Trader Dashboard helps you log every trade, track your success rate with different patterns, and identify which setups work best for your trading style.
Variations of the Pattern
The inverse head and shoulders does not always form perfectly:
- Sloping neckline: Sometimes the neckline slopes upward or downward. Upward sloping necklines are more bullish
- Complex head and shoulders: May have multiple shoulders on each side or a double head
- Unequal shoulders: One shoulder deeper than the other is common and the pattern remains valid
Summary
The inverse head and shoulders is a powerful bullish reversal pattern that signals the end of a downtrend. Key points to remember: wait for the neckline break before entering, watch for volume confirmation, set stops below the right shoulder, and use the pattern height to calculate your price target. Combined with proper risk management and confirmation from other indicators, this pattern can be a valuable addition to your trading arsenal.
Want to learn more chart patterns? Check out our guides on support and resistance and how to read stock charts.