What is Reverse Head and Shoulder chart Pattern?
Reverse Head and Shoulder is a chart pattern, formed by price action, with three swing bottoms placed side by side. It is very profitable reversal chart patterns. It is very reliable with 90% probability. This is created when there is a major profit booking or buying in a downtrend.
They are the pressure areas in a stock chart, which may be a major support area, or it may even be a major target area. Here most traders book profit on short trade and buying for long trade begins. The trend changes from downtrend to uptrend. The resistance trend line of this pattern is an almost horizontal line connecting the two swing tops of the pattern.
It is so named because the pattern is in the form of a reversed bust of a man, with central lower swing bottoms resembling head in reverse and two higher swing bottoms on its either side resembling shoulders in reverse. Hence the name Reverse Head and Shoulder Chart Pattern.
Trend is your friend. Dance with the friend. Tune to the trend.
There are two great forces which move the price up and down. They are demand and supply. Reverse Head and shoulder is the result of extraordinary increase in demand over supply for the stock.
These are pressure areas in a downtrend. These are major target areas or major support areas where most traders wish to book profit of their short position and buy stock to create long position. Here downtrend changes into an uptrend.
In a down trend the price keep making lower low swing lows and lower low swing highs. As the target area or the support area is approached there is increased buying. As the demand increases the price rises up forming a swing low which is lower than the previous swing low. This swing low forms the reverse head of this reverse head and shoulder chart pattern formation. The previous swing low which is higher than the present swing low forms the left shoulder of this pattern.
Because of extraordinary increase in demand over supply for the stock, instead of just rising 50% to 60% of previous swing range, the price rises almost to the level of the previous swing high which is the next immediate resistance zone.
As the price reaches the resistance area many traders wants to sell stocks because it is not only a better price to sell in view of previous price fall, but also it is ideal to sell just below the resistance. So there is an increase in the supply for the stock and the price falls.
Although many traders are selling and the price is falling, it is not backed by smart money. Major funds are not selling. Instead they are interested in buying at this level. This time the price does not fall below the previous swing low. As it falls half way through buying pressure increases and the price rises making a new swing low which is higher than the previous swing low. This forms the right shoulder of this reverse head and shoulder formation.
Between the three swing bottoms which form the reversed head and shoulders of this pattern, there lies two swing tops. A trend line connecting the highest points of these swing tops and extended to right forms the resistance line for this pattern. This line is termed as neck line of this reverse head and shoulder formation.
Study the chart given below.
This chart shows a Bullish Reverse Head and Shoulder Chart Pattern which is the bullish reversal pattern in a downtrend.
Pattern trading is one of the strategies of making money in stock trading. Among the chart patterns reverse head and shoulder chart pattern formation gives us the opportunity to cover our short position and enter a long trade. These trades will have high rate of success.
What is invisibly going on in the market is very well expressed on the visible chart. The formation of reverse head tells us that there is heavy buying of the stock. The rising swing of the head, instead of taking resistance at 50% or 61.8%, rises above 78.6% which is an indication of the underlying strength.
Next the price fails to make lower swing low below the head and forms a higher swing low. Higher high swing low tells us that the market is not in a downtrend.
As the price rises to make the reversed right shoulder, the price faces the resistance of the neck line of the reversed head and shoulder pattern. When it breaks this resistance and rises above the previous swing high an uptrend begins. By definition uptrend is marked by higher high swing highs and higher high swing lows.
The moment you see a stock making a reversed head and shoulder chart pattern cover all your short position and get ready to go long above the neckline. Protect this long trade by placing a stop loss sell order below the reversed right shoulder.
Once the price breaks out above the neckline, 50% of the time it pulls back to test the neckline. Neckline was earlier resistance area which has now turned into a support area after the price has risen above it. Once the price rises after testing the neckline support, move the stop loss sell order to just below the swing low formed at the neckline.
The minimum target for this long trade is equal to the maximum depth of the reversed head measured from neckline and applied above the neckline from the break out point. Though this is the minimum target, many times the reward will be many times this which increases the risk to reward ratio.
Study the chart given below.
This chart shows a Bullish Reverse Head and Shoulder Chart Pattern which is the bullish reversal pattern in a downtrend. The price has risen four times its minimum target. This chart is same as above chart continued in time. Here the risk to reward ratio is 1:5.
Reverse Head and shoulder without pullback performs better than the one with pullback. Tall or narrow patterns perform better than short or wide ones. Patterns which break out with heavy volume outperform those which breakout with less volume. A low volume breakout is not an indicator of an impending failure. Patterns with a horizontal neckline or up sloping neckline perform better than those with down sloping neckline.
There are many more chart pattern formation used in pattern trading. Some of them are listed below. You may click on the name of each chart pattern listed below to learn and understand more about them.
Continuation Chart Patterns