The inverted head and shoulders reversal pattern

  • 28 Feb 2017
  • By Trading Central
  • Topics: Metals

The inverted head-and-shoulders, a reversal pattern, takes shape at the end of a bearish trend. The formation consists of a left shoulder, a head, a right shoulder and a horizontal (or slightly declining) neckline that links shoulders’ highs. For a proper bullish reversal psychology, benefiting from an additional positive technical element is more comfortable (such as a golden cross between the 20 & 50 moving averages or a strong rise in volume/open interests,...). This pattern is confirmed when prices break through the neckline. A perfect timing is to wait for a pullback on the neckline, which will play a support role (polarity principle).

ADAPTED OPTION STRATEGY: BULL CALL SPREAD

As the upside potential is limited by the pattern’s theoretical target & the November’s highs, a bull spread allows you to lower the cost of the strategy (in comparison to a straight long call) by selling a call out of the money. As a result, the strategy consists of the simultaneous purchase of a call with a Strike at 1770c (between 17.35 and 18.7), and the sale of a call with a Strike at 1900c (slightly above 18.7). The position is initiated when the price throws back on the neckline (17.35).

BULL PUT SPREAD: Leg 1

Trading Symbol SO K7
Option Type CALL
Option Strategy BUY
Strike 1770
Expiration May 2017

BULL PUT SPREAD: Leg 2

Trading Symbol SO K7
Option Type CALL
Option Strategy BUY
Strike 1900
Expiration May 2017

ADAPTIVE FUTURES STRATEGY

Trading Symbol SI K7
Strategy LONG
Entry Point 17.35
Target 18.70
Stop Loss 16.70
Contract Expiry May 2017

THE INVERTED HEAD AND SHOULDERS REVERSAL PATTERN: SI K7 FEBRUARY 3RD

ACTUAL OUTCOME

POTENTIAL GAIN PER CONTRACT

The theoretical target of this strategy is a measured move up equal to the distance between the pattern’s low (red line) and the neckline at 17.35 indicated by the arrows and reported from this neckline for a total around November’s highs.

POTENTIAL DOWNSIDE PER CONTRACT

If the price falls below the right shoulder where the stop-loss is placed (16.7), the position is closed. The goal after entering the position is to adjust the stop-loss to the neckline of the pattern (17.35) as soon as the trade is working in your favor as the neckline usually acts as support once the pattern has been confirmed.

Inverted Head and Shoulders happening now in the markets

Crude Light: CL

Palladium: PA


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