Every trader aspires to buy low and sell high, but few are able to muster the courage to go against the herd and buy when the downtrend reverses.
When prices are falling, the mood is negative and the fear is extremely high, but at times like these the inverse head and shoulders pattern (IHS) can occur.
The (IHS) pattern is similar to the regular H&S top pattern, but the formation is inverted. Upon completion, the (IHS) pattern signals the end of the downtrend and the beginning of a new uptrend.
Inverse head and shoulders basics
The (IHS) pattern is a reversal setup that forms after a downtrend. It has a head, left shoulder, and right shoulder that are upside down and placed under a neckline. A breakout and close above the neckline complete the setup, suggesting that the downtrend has reversed.
As shown above, the asset is in a downtrend, but after a significant decline, value buyers believe the price has reached attractive levels and will begin bottom fishing. When demand exceeds supply, the asset makes the first low from the left shoulder and price begins a relief rally.
In a downtrend, traders sell on rallies. The bears sell aggressively after the pullback and the price drops below the first low, making a lower low. However, bears have been unable to capitalize on this weakness and resume the downtrend. The bulls buy this slump and start a recovery rally that forms the head of the pattern. As the price approaches the previous high where the rally stalled, the bears jump in again.
This begins the decline, culminating in the formation of the third low point, which is stopped almost at the same level as the first low point, as buyers expect a trend reversal and buy aggressively. This forms the right shoulder of the setup. The price is turning up and this time the bulls manage to push the price above the neckline and complete the pattern.
The neckline will then become the new lower bound as traders buy the dip to support this. This signals the beginning of a new uptrend.
Identify a new uptrend with the (IHS) pattern
Bitcoin (BTC) has been in a downward trend since forming a local high at $ 13,970 on June 26, 2019. The buyers stepped in and stopped the decline in the $ 7,000 to $ 6,500 support zone, forming the left shoulder of the (IHS) pattern. This sparked a détente rally that pushed the price down to $ 10,450. At this level, short-term bulls made gains and bears opened short positions to resume the downtrend.
Aggressive sales broke the support at $ 6,500 and the Bitcoin / Tether (USDT) pair plummeted to $ 3,782.13 on March 13, 2020. The bulls viewed this fall as a buying opportunity and that kicked off a strong recovery rally that hit nearly $ 10,450. This second hollow formed the head of the setup.
The right shoulder was flat as selling pressures were reduced and the bulls did not wait for a deeper correction to buy. Eventually the bulls pushed price above the neckline on July 27, completing the (IHS) pattern.
The bears tried to lure the bulls into the trap and they pulled the price back to the clipping. Although the price fell just below the cutout, traders did not allow the pair to hold below $ 10,000. This indicated a change in sentiment. Bullish momentum increased as buyers pushed the price above $ 12,500.
How to calculate the sample goal of an IHS setup
To calculate the Minimum Target Target of the (IHS) pattern, calculate the depth from the neck line to the deepest point to form the head. In the example above, the cutout is about $ 10,450, and subtracting the lowest point at $ 3,782.13 results in a depth of $ 6,667.87.
This value is then added to the breakout level, which in the example above is $ 10,550. This results in a target goal of $ 17,217.87. When a trend changes from the bottom up, it can miss or exceed the target. Therefore, traders should use the target as a guide and not discard their positions just because the level has been reached.
Patience pays off because sometimes the pattern fails
No pattern is successful on every breakout and traders should wait for setup to complete before initiating trades. Sometimes the pattern structure forms, but the breakout does not take place. Traders who anticipate the completion of the pattern and initiate trades fall into the trap.
For example, Chainlink’s LINK hit $ 4.58 on June 29, 2019 and started a correction. Buyers sought to stem the decline in the $ 2.20 to $ 2.00 zone. This formed an (IHS) pattern with a head and two shoulders as seen in the graphic above.
Even though the price hit the cutout on August 19, 2019, buyers couldn’t push the price past it. Because of this, the pattern was not completed and the buy signal was not triggered.
The LINK / USDT pair turned down from the neckline and broke below the top of the setup at $ 1.96, invalidating the pattern. This has caught traders who may have bought in anticipation of a trend reversal.
The central theses
The (IHS) pattern could be a useful tool for traders to jump on a new uptrend when it starts. There are a few important points to keep in mind when using this setup.
Traders should wait for the pattern to complete, which happens after the price breaks and closes above the neckline, before entering long positions. A breakout from the neckline that occurs at above-average volume is more likely to lead to a new uptrend than a breakout at low volumes.
When a trend is reversed, it usually lasts a long time. Therefore, traders shouldn’t be in a hurry to drop positions just because the model goal has been met. At other times the pattern completes but quickly reverses direction and the price crashes. Traders should closely monitor the other indicators and price action before taking a position.
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