An inverse head and shoulders pattern predicts the reversal of a downtrend. It's identified by:
1. A stock falling to a trough, then rising.
2. Falls below the previous trough, then rises.
3. Falling again, but not as low as the second trough.
Refer to the image below. After the final trough (right shoulder), the price rises to the resistance (diagonal down sloping red line), also known as the neckline. Traders with stock trading, options trading, and futures trading backgrounds would likely enter into a long position when the price rises above the resistance of the neckline. The first and third troughs are the "shoulders", and the second trough is the "head." The head MUST dip below the two shoulders in order for the pattern to be considered an Inverse Head & Shoulders.
After the initial break of neckline resistance, the stock will more than likely return but not surpass the "neckline" before rising again. This is commonly referred to as a retracement.
Here's a picture we pulled from the trading room to give you a visual example of the pattern.
An Inverse Head & Shoulders pattern is a bullish technical pattern. It indicates the reversal in a downtrend, meaning it implies the stock will reverse to the upside.
The measuring implications rely on the height between the lowest point on the head and the neckline directly above that area (thin yellow oval on image above).In the example above, the bottom of the head resides at approximately 38 and the neckline directly above that point resides at approximately 57.50. This results in a height of 19.50.
The height is to be added to the price level at which neckline resistance breaks (smallest white oval), which resides at 54.50 in our example. Therefore, add 19.50 to 54.50 to get the target, which is 74.00 in this case (small yellow oval).
That pretty much sums it up!
Related terms: rounding top pattern, rounding bottom pattern, head and shoulders pattern, cup with handle pattern