Stock traders and crypto-traders see the inverse head/shoulders pattern in crypto as a sign that a bullish trend is about to reverse.
While every trader wants to sell high and buy low, only a few traders are able to stand out and buy when the downtrend is in its favor.
If prices fall, fear and sentiment are at their highest. However, it is in these times that the inverse head-and-shoulders (IHS), pattern can emerge.
Although the (IHS) pattern looks similar to the H&S top pattern in terms of construction, the formation is inverted. The (IHS) pattern is completed and signals the end of the current downtrend and the beginning of a new upward trend.
Basics of inverting the head and shoulders
The (IHS-) pattern is a reversal set up that occurs after a downtrend. It features a head, left shoulder and right shoulder that are placed above a neckline and upside down. The setup is complete with a breakout and close to the neckline, which indicates that the downtrend has reversed.
The asset is currently in a downtrend, but value buyers have seen a significant drop and believe that the price has reached acceptable levels. They will begin bottom fishing. The asset forms the first trough at the left shoulder when demand exceeds supply and prices begin a relief rally.
Trader sells on rallies in a downtrend. When the price falls below the first peak, the bears will sell aggressively. The bears cannot capitalize on this weakness to resume the downtrend. The pattern’s head is formed when the bulls take advantage of this dip to start a rally. The bears step in again as the price reaches the peak at which the rally had stopped.
This begins the decline that leads to the formation of the third and final trough. Buyers anticipate a turnaround so they purchase aggressively. This is the right shoulder. The pattern is completed when the price rises and the bulls push it above the neckline.
As traders purchase the dip to this support, the neckline becomes the new floor. This signalizes the beginning of a new uptrend.
Identifying a new trend with the (IHS-) pattern
Bitcoin (BTC) had been in a downtrend since forming a local top at $13,970 on June 26, 2019. The decline in the $7,000-$6,500 support zone was stopped by the buyers, who formed the left shoulder (IHS). The price rose to $10,450 after this relief rally. Short-term bulls made profits at this point and bears took short positions in an attempt to resume the downtrend.
Aggressive selling broke the support at $6,500 and the Bitcoin/Tether (USDT) pair plunged to $3,782.13 on March 13, 2020. Bulls saw this as a buying opportunity, and that led to a strong rally that reached close to $10,000. The setup’s head was formed by the second trough.
Because the selling pressure had decreased, the right shoulder was not as deep as it should have been and bulls didn’t wait for a deeper correction before they bought. The bulls finally pushed the price over the neckline on July 27 to complete the (IHS).
The bulls were caught by the bears, and the price fell back below the neckline. The price fell just below the neckline but traders refused to allow the pair below $10,000. This indicated a shift in sentiment. Bullish momentum increased as buyers drove the price to $12,500.
How to calculate the pattern goal of an IHS setup
Calculate the distance from the neckline to form the head in order to calculate the minimum objective of the IHS (IHS) pattern. The neckline in the example above is approximately $10,450. Subtracting the lowest point, which is $3,782.13, gives $6,667.87.
This value is then added onto the breakout level. In the example above, it is close to $10,550. The target objective is $17,217.87. If a trend moves from down to upward, it can fall short of or exceed the objective. Therefore traders should not abandon their positions because they have reached the target.
Sometimes the pattern doesn’t work out so patience pays off
Every breakout is not a success so traders need to wait for the setup before they can start trading. Sometimes the pattern structure may form but the breakout doesn’t happen. Traders who attempt to preempt the pattern’s completion and initiate trades are trapped.
For example, Chainlink’s LINK topped out at $4.58 on June 29, 2019, and started a correction. The buyers tried to stop the decline from $2.20 to $2.00. As you can see in the chart, this created an (IHS), pattern that included a head with two shoulders.
Despite the price reaching the neckline on August 19, 2019, buyers couldn’t push it above that level. The pattern was not completed and the buy signal didn’t trigger.
The LINK/USDT pair fell below the neckline, breaking below the head at $1.96, invalidating this pattern. This traps traders who might have bought in anticipation of a trend reverse.
The key takeaways
If traders are looking to get on top of a new uptrend, the (IHS) pattern can be an effective tool. These are some important points to keep in mind when using this setup.
Before initiating long positions, traders should wait for the pattern’s completion, which occurs after the price breaks above the neckline. If the neckline is breached on high volumes, it is more likely that a new uptrend will be established than if it is breached on lower volumes.
A trend that reverses is usually a long-lasting one. Trader should not rush to sell positions if the pattern target is met. Sometimes, the pattern reverses and the price drops. Before negotiating a position, traders should be aware of the price action and other indicators.