What Is an Inverse Head and Shoulders Pattern?

The inverse head and shoulders pattern is a chart formation in technical analysis that signals a shift in market sentiment. It is considered a bullish reversal pattern, indicating a prevailing downtrend may be nearing its end and an uptrend could begin. This pattern is the inverted version of the classic head and shoulders pattern, which signals a bearish reversal. Understanding this formation provides insights into market dynamics and potential future price movements.

Identifying the Pattern’s Components

The inverse head and shoulders pattern is characterized by three troughs in an asset’s price chart, along with a resistance level known as the neckline. The formation begins after a sustained downtrend, establishing the context for a potential bullish reversal. The first trough is the “left shoulder,” where the price declines and then rallies, indicating an initial phase where selling pressure temporarily subsides.

Following the left shoulder, the price falls to an even lower point, creating the “head” of the pattern. This lower low suggests a final push by sellers before buyers begin to exert more influence. After the head, the price rallies again, often reaching a similar level as the rally after the left shoulder. The final component is the “right shoulder,” which forms when the price declines once more but does not reach the depth of the head, bottoming out at a level comparable to the left shoulder.

The “neckline” connects the high points reached between the left shoulder and the head, and between the head and the right shoulder. This line acts as a resistance level that the price must break above to confirm the pattern’s validity. While the neckline can be horizontal, it may also be upward or downward sloping, depending on the specific price action.

Interpreting the Pattern’s Signals

The inverse head and shoulders pattern signals a bullish trend reversal. This pattern suggests that the selling pressure that drove the preceding downtrend is diminishing, and buying interest is gaining strength. The inability of the price to make a new low after the head, evidenced by the higher low of the right shoulder, indicates a shift in market sentiment.

The pattern completes when the price breaks above the neckline. This breakout point is a trigger for anticipating upward price movement. Calculating a potential price target is a key aspect, providing an estimated upward movement after the breakout. This target is determined by measuring the vertical distance from the lowest point of the head to the neckline.

This measured distance is then projected upward from the breakout point on the neckline. For instance, if the head is at $20 and the neckline is at $30, the vertical distance is $10. Upon a confirmed breakout above the neckline, the price target would be approximately $30 + $10 = $40. This calculation provides a tangible objective for the potential rally.

Confirming the Pattern’s Validity

The reliability of an inverse head and shoulders pattern increases with confirmation from additional factors. Volume analysis plays an important role in validating the pattern’s strength. Trading volume should decrease during the formation of the left shoulder and the head, reflecting waning selling pressure.

During the formation of the right shoulder, volume might remain lower than the head, but a surge in volume is expected when the price breaks above the neckline. This increase in buying volume on the breakout confirms buyers are entering the market and the trend reversal is likely sustained. A breakout is considered valid when the price closes above the neckline, not just briefly touching it.

Another confirmation signal is a “retest” of the neckline. After breaking above the neckline, the price sometimes retraces to this level, testing it as new support. If the neckline holds as support and the price resumes its upward movement, it further validates the pattern and offers a secondary entry opportunity. Combining these volume and retest confirmations helps mitigate the risk of false breakouts, where the price moves above the neckline but quickly reverses.