Things You'll Need:
- Online Brokerage Account
- Real Time Charts
- Basic knowledge of technical analysis
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Step 1
An inverse head and shoulders pattern can be spotted on any time, and traded in the same manner. It doesn't matter if it's a 1,5,10, or even 60 minute chart. The chart that I will be using is a 10 minute chart of the symbol XLF, which tracks the movements of the financial stocks. An inverse head and shoulders pattern will form when the price carves out a left shoulder, head, and right shoulder. It is fairly easy to recognize as the two shoulders will dip to nearly the same price level, and the head will clearly mark the lowest price. I have outlined the inverse head and shoulders pattern in white.
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Step 2
Once the right shoulder begins to form, you should be able to draw in the neckline of the pattern. The neckline can be drawn by connecting the top of the left shoulder to the top of the right shoulder. I have drawn the neckline in yellow.
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Step 3
Not all inverse head and shoulders patterns play out. Once the price breaks and closed above the neckline, you will enter your trade. If price fails to break the neckline, then the pattern failed. I have drawn a pink arrow to indicate where price broke above the neckline, which is where you would enter your buy order.
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Step 4
Inverse head and shoulders patterns are not 100% accurate so it is important to place a stop loss on the trade. This will protect you in case the pattern fails. Stop losses can vary based on risk tolerance, but a good place to put a stop loss is just below the neckline. I would recommend anywhere from a 1/2% to 1% below the neckline level.
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Step 5
The last and most exciting step is when and how much profit to take from the trade. You can take the guesswork out if you measure the price target of the inverse head and shoulders pattern. If you draw a vertical line from the lowest price of the head to the neckline, this will give you your price target. In this example, the pattern measures about 50 cents. To find out the price target, add this amount to the price at which the pattern broke above the neckline. Price broke out at about $12.60, which would give you a price target of around $13.10. As you can see, the pattern played out perfectly and the price rose to $13.08 by the end of the day. I have drawn a red line on the chart to indicate the height of the pattern, which is also drawn above the breakout to calculate the target price of the move. Once the target is met, take your profit and begin searching for the next technical set up.
