Standard and Inverse Head & Shoulders are two sides of the same coin and are the exact opposite of each other. That said, both signal the end of a directional move and hint at a reversal.
A standard Head & Shoulders is always formed at the top of the chart and, upon successful completion, signals a bearish reversal.
An inverse Head & Shoulders is the exact opposite. It is always formed at the bottom of the chart and signals a bullish reversal.
Why Do Reversals Occur?
In hindsight, price reversal occurs when the trend in any one direction is about to end. That is to say, a trend is about to change, either in the short or long term.
The latter usually occurs when fundamentals stop supporting the direction of the ongoing trend due to a drastic shift in economic factors. It could either be that economic data starts to print weaker numbers or, alternatively, better than expected economic activity starts to point to a stronger recovery.
These fundamental factors could very from a shift in monetary policy or, in rare cases, external unforeseeable factors like war or a virus outbreak.
When a reversal is impending, price tends to correct in the opposite direction. Before it corrects, however, it usually goes into a consolidation mode, moving in a zig-zag fashion. Thus, it puts in a pattern that becomes recognizable.
Standard and Inverse Head and Shoulders Patterns
There are many reversal patterns to choose from, but we will discuss the most prominent one.
Head & Shoulders
This is one of the most reliable and prominent reversal patterns a trader can see on a chart.
It is always formed at the top of the trend. When prices trend higher and an H&S pattern appears, it signals an end to the trend and hints at a bearish reversal.
The H&S pattern has three visual characteristic stages to complete:
- The price is trending higher; it forms a peak and declines back to its initial base where the price has lifted off from. Price is basically forming the Left Shoulder of the pattern
- The price surges up again taking out the previous peak high and forming a newer one. It then declines back to the previous base support. This new peak high is the Head.
- The price surges yet again from around the base support. However, the upside is sustained to or around the peak formed initially by the Left Shoulder. Then, the price ends up reversing once again and moves back to the base support. This is basically forming a Right Shoulder and consequently the Head & Shoulders.
The base support of the Shoulders (Left & Right) along with the Head is called the neckline. And when and if a bearish break occurs upon the completion of the Right Shoulder, it only then is called the Neckline break.
Inverse Head & Shoulders
This is the exact opposite of Head & Shoulders. It obeys the same rules but in the opposite direction.
How to Trade Standard & Inverse Head & Shoulders Patterns?
One can opt to trade them aggressively or trade them conservatively. An aggressive way is to buy the break of the Neckline. A trader can get into the trade while the break of the Neckline is in progress. Note that, at times, (more often than not) we have false breakouts and trades can be easily stopped out.
A conservative way to trade the H&S pattern is to wait for a valid breakout of the neckline. Once, the breakout is confirmed, a trade could be opened in the same direction as the Neckline breakout. More conservative traders, however, will usually wait for a retracement before getting into the trade.