Strategies - Trend Reversal Patterns

The sideways price action of a reversal pattern signifies that upon breaking out of the pattern there will be a turnaround in the current trend.

We will be investigating the Head and Shoulders and Inverse Head and Shoulders on this page. Double Tops and Bottoms and Triple Tops and Bottoms will be discussed on the next page.

Other reversal patterns such as Rounded Tops and Bottoms, V-Formations, and Diamond Formations are not as common and harder to see. Rounded Tops and Bottoms will be discussed briefly on the next page while you can check our glossary for some information on V-Formations and Diamond Formations.

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Head and Shoulders
The Head and Shoulders pattern is one of the most classic patterns in a technical analyst’s toolkit.

This three-peak formation is named for its resemblance to a head and two shoulders. The center peak (head) protrudes above the remaining two peaks (shoulders), which are set at or close to identical levels. The common line of support for all three peaks, which does not have to be a horizontal line, is known as the Neckline. The final downward penetration of the neckline confirms the start of a new downward trend.

There is a chance that even after there is a break of the neckline that the trend may not reverse. A good validation of a reversal would be if the break is significant or if the neckline is tested and it turns from support to resistance. Also, a trader should look and see if momentum was higher during the formation of the left shoulder compared to the right shoulder as this would indicate that buying pressure is decreasing and a true reversal pattern is taking place. During a true head and shoulders reversal, the downward move can be expected to be equal to the distance from neckline to head.

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Inverse Head and Shoulders

The inverse Head and Shoulder pattern follows the same model.

In the 4-hour chart below you can see that at first price is heading downwards. After the pattern forms, price reverses and there is a substantial move in an upward direction. Soon though price retracts and tests the neckline.

The neckline holds as support, and the uptrend continues, completing the reversal. You can also see, from the momentum indicator, that selling pressure eases by the time the right shoulder is forming.

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