Classic head-and-shoulder patterns are often used to spot breakdowns, before a stock price drops. Learning how to find and trade “inverse” head and shoulder breakouts can be an effective strategy for finding new long trading entries as they’re about to occur. In this article we’ll look at various examples of how to trade this strong reversal pattern.
Inverse Head and Shoulder Patterns For Swing Trading
New entries can be found following a inverse head and shoulders pattern, which looks like a series of 3 “cups”, in which new buyers come in at new highs. As you can see in Figure 1, Endo Health Solutions Inc ($ENDP), there is a left shoulder, a “head”, and a right shoulder. The ‘neckline’ connects the top of each shoulder, and the trading entry is placed just above this right shoulder high.
The basic pattern is also illustratated in Figure 1, so that you can see what to look for. Note that this pattern may often occur at a slight angle, as shown in the chart’s actual price action. These entries are also effective in helping traders spot uptrend reversals following sell pressure.
For risk management, typical swing trading entry and exit setups are as follows: entry signal is placed .35 cents (thirty-five cents) above the high of the right shoulder. A maximum of 1.0 point stop-loss and trailing stop is used. Scaling in to add to winning trades is done every 1 point, to double the share size during an uptrend, using a 1-point trailing stop to lock in profits.
Daily Candlestick Charts and Inverse Head and Shoulder Trades
Using a 90-day daily candlestick chart is an excellent way to scan for strong entry patterns. It may be challenging at first to spot inverse head-and-shoulder long patterns. It’s not always necessary to see a classic perfectly-formed pattern, as these are rare. The key is to find one that’s strong enough to generate a successful entry, and shows momentum of new buyers entering at new highs.
In Figure 2, MGM Resorts International ($MGM), the left shoulder area is seen from approximately June 10th through 18th, the head (bullish cup) is formed June 19th through 28th, and the right shoulder is July 2nd through 8th. Seeing these multiple cup patterns helps identify new entries, as price action takes out new highs.When drawing the neckline, it’s best to be conservative and use the candles that best mark out a clear cup pattern (which looks like the letter “U”). Entering too soon during consolidation often leads to choppy entries, so it’s smart to wait until new highs are confirmed prior to entering.
Day Trading With Inverse Head and Shoulder Breakouts
Using 1-minute candlestick charts to spot long entries for intraday trade opportunities can help traders quickly find potential trading opportunities. In Figure 3, Tesla Motors Inc. ($TSLA) we see a this inverse head and shoulder pattern with major resistance being near 149.5 on the neckline and both shoulders.
As is seen in the chart, correctly drawing the neckline would have us wait until a full thirty minutes after the rightmost shoulder was formed, prior to entering the trade. Connecting the shoulder tops to establish the proper resistance area using the neckline can be a significant factor in helping wait until a very strong breakout is in progress, during which the trade entry is made.
Waiting for a good trade setup to materialize is where the inverse head and shoulder strategy is especially useful. Traders often enter too early and get stopped out during consolidation or pullback areas. Using a correctly-marked inverse head and shoulders pattern can help with this, b requiring traders to wait until after the rightmost shoulder has formed using the 1-minute candlestick chart, prior to entering their trades.
Ken Calhoun is a trading professional who has traded millions of dollars of equities since the 1990s, and is the producer of multiple award-winning trading courses and video-based training systems for active traders. He is a UCLA alumnus and is the founder of TradeMastery.com and DaytradingUniversity.com, popular online educational sites that reach tens of thousands of active traders worldwide.