Trading Inverse Head and Shoulders Patterns by Suri Duddella One of the most popular chart patterns in market analysis is "Head and Shoulders" (H&S) pattern. The H&S patterns form near market tops in an established sideways to up trending or bullish markets. The H&S patterns are reversal patterns as they reverse its prior uptrend and follow a bearish or downtrend from its breakdown. These patterns are signified by three successive peaks (tops) resembling two shoulders on both sides and a head in the middle. The head is the largest of the three peaks. An Inverse Head and Shoulders (Inv. H&S) pattern is the head and shoulders pattern upside down (mirror image) and follow similar structure and trading rules (in reverse) as H&S pattern. The Inv. H&S patterns are also reversal patterns and form in established downtrends. Inverse H&S Pattern Components Head & Shoulders: The 'head' and 'shoulders' in Inv. H&S patterns are formed by three successive troughs (bottoms) opposed to peaks (tops) in H&S patterns. The middle trough (head) is the deepest in the pattern. The ratio of the height of the head to the largest of shoulders height and should be less than 0.78. The size of the head is measured as the vertical distance from the neckline to the trough of the head. Neckline: The neckline is formed by connecting the highs of shoulders and the high of the head in the Inv. H&S pattern. These are reaction highs formed to define the pattern structure. The neckline can have up, down or horizontal slopes. Upward slopes tend to be more bullish than downward slopes. In my experience, the patterns with horizontal necklines produce better results. Volume: Volume plays a significant role in pattern structure and its validity of trading rules. Price breakouts from neckline must be supported by expanded volume for a valid short Trading Inverse Head & Shoulders Pattern Entry: After right-shoulder formation and pattern completion, if price closes above the neckline with increased volume, enter a long trade above the breakout bar's high. Stops: 1. Place a stop below the middle of neckline and rightshoulder 2. Place a final stop below the low of the rightshoulder. Targets: Targets are projected from the neckline level. Measure the height of the head and use Fibonacci ratios to compute targets. The first target range is 62-79% of the height of the head and second target range is 127-162% above neckline. entry. Volume build up in the left shoulder is usually higher than the volume in right-shoulder. During the head formation (bottom), the volume in the first half of the head may be higher than volume in the second-half. An increased volume above neckline for a breakout signifies completion of the pattern. Success/Failure Ratios: Inv. Head and Shoulders (SF Ratio: 0.682) have higher success/failure ratio than Head and Shoulders pattern (0.59).
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