Technical analysis: Bitcoin – Inverse head and shoulders

Bitcoin price

A potential inverse head & shoulders is setting up on the Bitcoin chart. Whilst I won’t be winning any prizes for originality with this analysis piece (every technical analyst and his grandmother will have spotted this) – keep in mind that correctly identifying a pattern and trading it successfully are not the same thing.

First, the basics. An inverse head & shoulders pattern is a bullish reversal pattern which signals a change in price direction from a downtrend to an uptrend. Whilst the left shoulder and head are a part of the downtrend forming lower lows, the right shoulder is a higher low and is the first signal that an uptrend may be forthcoming.

The local highs form a resistance zone which the price will need to break through in order for the head & shoulders pattern to be validated. Joining the local highs with a trend-line forms the “neckline”. A break of the neckline to the upside is the second signal of trend reversal and this,┬átraditionally, is seen as the time to enter a long trade (buy signal).

With the above in mind, it is clearly not the correct time to be looking to enter long. We saw a solid move up with strong volume to form the right shoulder, but we are now headed towards the resistance created by the neckline. Remember that there is always a good chance that the price is rejected at the neckline and does not break through. For this reason it is advisable to only enter a long trade above the local high once the neckline break is confirmed. The breakout should ideally be accompanied by a spike in volume.

One of the appealing aspects about head & shoulders patterns is that they provide a fairly reliable target. To find the target, measure the height from the bottom of the head up to the neckline. Then project this distance up from the breakout point which will give you your target (illustrated by blue arrows). In this case the target falls within a resistance zone adding to the probability of this being a suitable target.

Also, consider that often after an initial breakout (green arrow), the price will drop back down (red arrow) to test the neckline which now acts as support off which the price rallies to target. This provides a “second bite at the cherry” to buy at the neckline if you missed the initial breakout.

Happy trading!

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