Price Action Classic Patterns
Knowledge of current economic events is a fundamental element of effective trading. In the case of currency pairs and indices, the ability to use the calendar is already satisfactory. Nevertheless, to assess market sentiment, it is worth following current events. In the case of instruments such as shares, tracking information from companies is a necessity.
Inverted Head and Shoulders Pattern
Formation: Inverted Head and Shoulders Pattern
The Inverted Head and Shoulders pattern is a reversal formation opposite to the traditional Head and Shoulders pattern. It signals the end of a downtrend and the beginning of an uptrend. This pattern consists of three troughs: two smaller ones (left shoulder and right shoulder) and one larger one (head), with the left shoulder lower than the right one. Similar to its counterpart, this pattern resembles the silhouette of a person's head and shoulders, but inverted.
What the formation looks like:
Left Shoulder:Price declines, forming the first trough.
After reaching the left shoulder, the price rises.
Head:Price declines again, forming a lower trough than the left shoulder.
After reaching the head, the price rises again.
Right Shoulder:Price declines again, but forms a higher trough than the head.
After reaching the right shoulder, the price rises.
Key points about the formation:
Volume: Similar to the traditional Head and Shoulders pattern, volume tends to decrease as the pattern develops, with each subsequent trough, signaling a potential reversal of the downtrend.
Neckline: The line connecting the high points of the left and right shoulders. A breakout above this line confirms the Inverted Head and Shoulders formation.
Potential upside target: The height of the pattern measured from the neckline to the head can be used to estimate the potential price move after the neckline breakout.
How to trade based on this formation:
Confirmation of the formation: Wait for a breakout above the neckline as confirmation of the Inverted Head and Shoulders formation.
Entering the trade: After the formation is confirmed, consider opening a long (buy) position after the neckline breakout.
Stop-loss: Place a stop-loss order below the neckline to minimize risk.
Profit target: The height of the pattern measured from the neckline to the head can be used to estimate the potential price move after the neckline breakout.
Market context and confirmations:
Confirmation with other tools: Before entering a trade, confirm the Inverted Head and Shoulders signal with other indicators such as oscillators (e.g., RSI, MACD) or candlestick patterns.
Market context: Ensure that the Inverted Head and Shoulders formation appears in the right market context. For example, if it appears after a prolonged downtrend, it is more reliable.
The Inverted Head and Shoulders pattern can be a powerful tool in technical analysis, but like any pattern, it requires confirmation and context. Using additional tools and understanding the market context can increase the reliability of this pattern.
