Inverted Head Shoulder is an extremely famous model in the financial market in general and forex in particular. The reversal signal coming from the Head and Shoulder Inverse is quite reliable. Therefore, it is imperative that you know how to identify and understand how to enter orders with this pattern when learning about the trading method of price models. In the article below, we not only introduce you to the characteristics of the model with real examples but also offer the most effective trading strategies for this famous Head and shoulders model.
What is an Inverted Head and Head?
Inverse Head and Shoulders (Inverse Head and Shoulders) is a reversal pattern from down to up, including 3 troughs, in which the middle bottom is deeper than the other 2 troughs. If you already know the Head and Shoulders model, you will easily imagine the characteristics of the Reverse Head and shoulders.
In this model, when prices create three bottoms, they also form the top two peaks. Connecting these two vertices, we get a Neckline, a very important line when considering trading to the model. We will discuss this issue in more depth in the following sections.
Characteristics of Head and shoulders Inverse
Keep in mind that Head and Head Inversions appear in a downtrend because this is a reversal pattern from bearish to bullish and includes the following four key components:
- Left shoulder: The first bottom in the pattern, appearing after a downtrend.
- Top peak: The next bottom, falling deeper than the previous left shoulder.
- Right shoulder: This is the third bottom of the model and has the same price range as the left shoulder.
- Neckline: A line connecting two top price peaks of a pattern. You need to pay close attention to this line, depending on the circumstances where the neck line may be horizontal, upward or downward, and this will affect the way we trade in each situation.
Next, you need to understand that not all Reverse Head and Head models are equally reliable. Some models can show very strong reversal signals while others give a lower probability of success. Therefore, you need to understand the characteristics that increase the strength of the model, including:
- Before creating a pattern, the stronger the price drop, the steeper the chart is, the more reliable the reversal signal.
- The neckline is directed upward, which is most effective compared to the other two cases (horizontal or downward).
- The left shoulder (first bottom) higher than the right shoulder (third bottom) will increase the strength of the model.
The price target of Head Inverted Head
Buy signals in the model will be given when prices break above the neckline, whether it is horizontal or inclined up or down.
After breaking past the neckline, the price target of the pattern will be equal to the height of the top of the head calculated upwards. More specifically, you will measure the distance from the neck line to the top of the head, the second bottom of the model. Next, taking that distance plus the neckline breakout, we'll get the price target of the pattern. To make it easier to imagine, you can see the illustration below:
Psychological evolution of the Inverse Head and Head model
Why can an inverted Head and Head model cause the market to end its downtrend and reverse its upside? To understand this we need to understand the psychological evolution in the model.
The left shoulder and the top of the model show the strength of the downtrend when the market continuously creates 2 lower lows. The price rebound after creating the left shoulder is just a normal price action in a downtrend. Therefore, at this time the sellers are still in control of the situation and the bearish sentiment is covering the market.
However, a noticeable point appeared when the price increased to create a second peak and then dropped to create another bottom (right shoulder) but this time the market could not create a lower bottom than before, indicating that the downtrend has already began to weaken, the buyer gradually regained its strength. As you know, a downtrend is defined as a price movement consisting of lower highs and lower lows. Therefore, if the neckline is up, meaning that the second peak is higher than the previous peak and the right shoulder is higher than the left shoulder, the strength of the model will be increased because these movements confirm that the previous downtrend has ended. Ends and the market is ready to reverse. If the buyers are strong enough to push prices up and surpass the previous two peaks, the optimism will return to the market and will push prices higher.
Actual example of an Inverse Head and Head model
The first is an example of an Inverse Head Shoulder Shoulder pattern with a horizontal neckline on the AUDUSD H4 time frame chart. As you can see, the pattern below is quite symmetrical with 2 shoulders and 2 peaks at approximately equal prices. After crossing the neckline, the market reversed to go up.
Next is an example of an Inverse Head Shoulder Shoulder model with a neckline sloping down. The price pattern appears after a downtrend and ends with a breakout above the neckline, returning to test support and eventually rising.
The third case is the neck line facing up as shown below.
Instruction to deal with Reverse Head and shoulders model
This will be the most important part when learning about the Reverse Head-to-Head model because only the right trading can generate profits for you in the forex market with the lowest possible risk.
Entry point command
There are two methods of entering commands with this model.
Some traders who have identified the Reverse Head and shoulders model usually place one pending orders at the neck line. This method can bring attractive price, but the risk you encounter is false break.
Therefore, we can wait until a candle rises and closes above the neck line to look for trading opportunities. That means if the price goes up but then drops and closes below the neckline, we will continue to wait outside. This method will give you more certainty than the first method.
In the second method, we have 2 options on the command. The first option is to enter the buy order as soon as the candle closes above the neckline and the second option we use more often is to wait for the price to come back (pull back) to retest the neckline to enter the buy order like illustration below.
How to take profit (take profit)
Profit-taking points can be determined based on the model's price target. See the AUDUSD chart example below. It can be seen that the distance from the neckline to the bottom of the pattern's bottom is 175 pips. Thus, starting from the breakout point, we add 175 pips upwards, we will get a good price to take profit.
How to set a stop loss (stop loss)
The Reverse Head and Head pattern is very reliable, but no matter how strong the signal, we need to always set a stop loss to protect ourselves from the sudden fluctuations of the forex market. In this pattern, we can place a stop loss below the right shoulder if you enter the order at the breakout point, or place a few pips below the neck line if entering the order while waiting for the pullback price to retest the neckline.
summary
The Reverse Head and shoulders pattern is a very popular model by traders who trade on the price model. We hope through this article you have a good understanding of the characteristics and trading strategies with the Head and shoulders reverse model to be able to profit from forex. Good luck!
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Author: Tin Nguyen
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