Head and shoulders and inverted head and shoulders are two popular chart patterns used in technical analysis to identify potential bullish reversal signals in the stock market. These patterns are formed when the price of an asset makes three peaks or valleys, with the central peak or valley being the highest or lowest. In this article, we will explore the differences between head and shoulders and inverted head and shoulders, and which pattern signals a bullish reversal.
What is the Head and Shoulders Chart Pattern?
The head and shoulders pattern is a technical chart pattern that occurs when a security's price rises to a peak (the left shoulder), pulls back, rises again to an even higher peak (the head), pulls back again, and then rises to a third peak that is similar in height to the first (the right shoulder). The line connecting the lows of the two pullbacks is called the "neckline."
When the neckline is broken, it signals a potential trend reversal. The head and shoulders pattern is considered a reliable reversal pattern because it shows that the bulls (buyers) are losing steam and the bears (sellers) are taking over.
Identifying the Head and Shoulders Pattern
To identify the head and shoulders pattern, you need to look for the following:
A peak (the left shoulder)
A pullback
A higher peak (the head)
Another pullback
A third peak that is similar in height to the first (the right shoulder)
A neckline connecting the lows of the two pullbacks
Trading the Head and Shoulders Pattern
Once you've identified the head and shoulders pattern, you can trade it by placing a short position (selling) when the neckline is broken. You can set your stop loss above the right shoulder and aim for a profit target equal to the distance between the head and the neckline.
It's important to note that the head and shoulders pattern is not a guarantee of a trend reversal. Sometimes, the neckline will be tested before the price drops, so it's essential to wait for confirmation before entering a trade.
Another way to trade the head and shoulders pattern is to wait for a pullback to the neckline after the breakdown and then enter a short position. This approach can provide a better risk-to-reward ratio, but it requires more patience.
In addition, some traders use other technical indicators to confirm the head and shoulders pattern, such as volume, momentum, or oscillators. If the volume is higher on the right shoulder than on the left shoulder, it can indicate that the bears are taking control. Similarly, if the momentum indicator or oscillator shows divergence, it can signal a potential reversal.
What is the Inverted Head and Shoulders Chart Pattern?
The inverted head and shoulders pattern is a mirror image of the traditional head and shoulders pattern. It occurs when a security's price falls to a low (the left shoulder), bounces back up, falls again to an even lower low (the head), bounces up again, and then falls to a third low that is similar in depth to the first (the right shoulder). The line connecting the highs of the two bounces is the "neckline."
When the neckline is broken to the upside, it signals a potential trend reversal. The inverted head and shoulders pattern is also considered a reliable reversal pattern because it shows that the bears are losing control, and the bulls are taking over.
Identifying the Inverted Head and Shoulders Pattern
To identify the inverted head and shoulders pattern, you need to look for the following:
A low (the left shoulder)
A bounce back
An even lower low (the head)
Another bounce back
A third low that is similar in depth to the first (the right shoulder)
A neckline connecting the highs of the two bounces
Trading the Inverted Head and Shoulders Pattern
Once you've identified the inverted head and shoulders pattern, you can trade it by placing a long position (buying) when the neckline is broken to the upside. You can set your stop loss below the right shoulder and aim for a profit target equal to the distance between the head and the neckline.
As with the traditional head and shoulders pattern, the inverted head and shoulders pattern is not a guarantee of a trend reversal. Sometimes, the neckline will be tested before the price rises, so it's essential to wait for confirmation before entering a trade.
Another way to trade the inverted head and shoulders pattern is to wait for a pullback to the neckline after the breakout and then enter a long position. This approach can provide a better risk-to-reward ratio, but it requires more patience.
In addition, some traders use other technical indicators to confirm the inverted head and shoulders pattern, such as volume, momentum, or oscillators. If the volume is higher on the right shoulder than on the left shoulder, it can indicate that the bulls are taking control. Similarly, if the momentum indicator or oscillator shows divergence, it can signal a potential reversal.
Head and Shoulders vs. Inverted Head and Shoulders: Which One Signals a Bullish Reversal?
Both head and shoulders and inverted head and shoulders patterns are reliable reversal patterns that signal a potential trend change. The main difference is the direction of the trend change. The head and shoulders pattern signals a bearish reversal, while the inverted head and shoulders pattern signals a bullish reversal.
It's essential to look at the overall market conditions and other technical indicators to confirm the validity of these patterns. Traders should also be patient and wait for confirmation before entering a trade. By understanding and identifying these patterns, traders can add another tool to their trading arsenal and potentially profit from trend reversals.