Welcome to Lesson 3 of Forex Chart Formation Patterns. This lesson focuses on the inverse head and shoulders pattern, a powerful bullish reversal indicator used by traders after strong downtrends.
The inverse head and shoulders pattern is the bullish opposite of the classic head and shoulders. It forms after a strong downward move, composed of three lows: the left shoulder (a low), the head (a lower low), and the right shoulder (a higher low). A neckline connects the highs between the shoulders.
This pattern signals a potential trend reversal upward, giving traders an opportunity to enter long positions once confirmed.
Neckline Types in the Pattern
There are three common neckline types to watch:
- Downward sloping neckline: The weakest signal, as price may continue lower without reversing.
- Horizontal neckline: The most objective and reliable, offering clear breakout points and price targets.
- Upward sloping neckline: Has the highest chance of a successful reversal, indicating prior price strength.
How to Trade the Head and Shoulders Pattern
Here’s how you should approach it:
- Confirm the Pattern: Ensure that the formation includes a left shoulder, head, and right shoulder after a downtrend.
- Draw the Neckline: Connect the highs between the shoulders.
- Wait for Breakout: Enter a long position only after a decisive break above the neckline.
- Set a Price Target: Measure the vertical distance from the head to the neckline and project that distance upward from the breakout point.
- Manage Risk: Place your stop-loss just below the right shoulder to guard against false breakouts.
Using additional confirmation tools like volume spikes, RSI, or moving averages can further increase your setup’s strength.
Final Thoughts
The inverse head and shoulders pattern is a reliable bullish reversal indicator when properly confirmed by a neckline breakout. Recognizing the different neckline slopes improves trading decisions and risk management.
Use this pattern as part of a comprehensive trading strategy to maximize your forex success.
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