Candlesticks with Inverted Head & Shoulders Pattern
The Head & Shoulders (no relation to the shampoo) and the Inverted Head & Shoulders are very common patterns defined in the western technical analysis world. These have been studied thoroughly and shown to have predictable price moves in a majority of the charts in which they are witnessed. In this article, we will focus on the Inverted Head & Shoulders pattern.
The Pattern works as follows:
The stock starts heading down, bulls come in and drive prices higher forming the left shoulder. The bears drive the prices lower with renewed confidence. This creates a lower low than the left shoulder. The bulls come in again and prices start moving higher. They are not able to penetrate the previous resistance point, which can be described as a high supply low demand point. This portion is the Head of the pattern. The bears come in again once they notice the bulls are failing at resistance. This time however, most of the bears are fearful. They have already witnessed the bulls come in twice. This lack of selling pressure is enticing to the new bulls. They come back in and prices move higher again creating the right shoulder. The imaginary line which joins the resistance points of the pattern is termed as the ‘neck line’. If the bulls manage to close the prices above this line, then it is a clear victory for them. The bears will be forced to buy back the stock leading to further price appreciation. The probabilities are extremely high that the stock will continue in an uptrend upon breaking the neck line resistance. Always remember though, that the pattern is complete only on a successful break of the neck line. If the bulls cannot close prices above it on the third attempt, the pattern would be considered incomplete. One more point to note is that the neck-line can be sloping as well.
The following chart of OPSW shows an Inverted Head & Shoulders pattern. As a candlestick trader, how would you play the pattern? Analysis of the price movement at the point of resistance is made much easier with the help of candlesticks. The confirmation of seeing a tall bullish candle pierce the neck line will give the trader confidence that the pattern has completed. What would be a bonus to the trader? OPSW shows a gap up above the resistance neck line. The gap up represents a dramatic change of investor sentiment. The bulls have taken over the trend in an undeniable way.
On the other hand, if the trader would have noticed a Doji or a Shooting Star form as the price approached the neck line, it would have been a different scenario. It could have been analyzed that the bulls will not be able to complete the pattern. In this case it would be better to put your money in other high probability profitable situations.
Chart courtesy stockcharts.com