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High-Probability Trade Setups: A Chartist's Guide to Real-Time Trading by Tim Knight

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Chapter 15

Inverted Head and Shoulders

Something very unusual about the head-and-shoulders pattern is that it has a doppelganger called the inverted head-and-shoulders (IH&S) pattern. While the H&S pattern ideally precedes a top, the IH&S precedes a bottom. This bottoming pattern quite literally turns everything about the H&S pattern on its head, since the direction is the opposite, but all the other rules are the same.

DEFINITION OF THE PATTERN

The criteria for this pattern are as follows:

  • Left shoulder: A descent in price (perhaps following a long, major drop in the stock's value), a leveling, and then a strengthening back to a certain support level known as the neckline. The trading volume during this period should ideally increase notably.
  • Head: A further descent in price, dropping beneath the low set by the left shoulder, once again leveling off and ascending back to the neckline.
  • Right shoulder: A final descent in price but on lower volume, ideally not going as low as the left shoulder (and certainly not going as low as the head), a leveling off, and an ascent back to the neckline, which it finally breaks above on strong volume.

The target price is the value of the price range of the pattern added to the neckline. For example, if a neckline is at $20, and the bottom of the head is $15, the difference is $5. Therefore, $20 (the neckline) plus the range of $5, equals the target price ($20 + $5 = $25). This hypothetical setup therefore anticipates a 25 percent increase in ...

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