Inverse head and shoulders formation

A buy signal from an inverse head and shoulders formation signals increasing optimism among investors and the beginning of a rising trend. Formations like this are considered some of the most reliable formations in technical analysis.

An inverse head and shoulders formation is a bottom formation which marks the end of a falling trend. The formation consists of a left shoulder, a head and a right shoulder, connected by a neckline. The buy signal is triggered when the price breaks upwards through the neckline heading up from the right shoulder.

On the left shoulder investors are negative. The trend is falling and it does not look good for the company. As the pessimism wanes, the head is formed. Here the stock might break out from a falling trend channel and buyers become more aggressive or sellers more passive. On the right shoulder, the pessimists are unable to push the price downwards to a new bottom. Instead buyers push the price upwards through the neckline and the buy signal is triggered. The stock breaks upwards through resistance at the neckline and a rising trend begins.

A stock that has triggered a buy signal from an inverse head and shoulders formation is indicated to continue rising, for at least as long as the formation is high.

Please note that false buy signals from small inverse head and shoulders formations may arise in long term falling trends. Sometimes these can be spotted by a reduction in volume on the break. This indicates little strength in the price movement, and the stock can easily break down again and continue the falling trend. In such situations it can be advantageous to keep the stock and wait to see what happens also after the buy signal. This is especially the case if the stock is still in a falling trend or faces resistance from previous tops.

Sometimes good indicators of a coming break exist before the neckline is broken. Volume reduction on or towards the bottom of the right shoulder indicates that the sellers are passive. Increasing volume on the way up from the head or up from the right shoulder indicates that buyers are aggressive. Aggressive buyers and passive sellers are a good mix and a clear indication of increasing optimism in the stock and a coming break upward. In such situations it can be advantageous to buy before the buy signal is triggered.