As for the technical analysis in the stock market, there probably is no technique that is as famous or popular as the Cup and Handle Pattern. This stock chart formation was named after William J. O’Neil by Benjamin Graham in his book “Stock Market: How to Make Money in Stocks” and it really works out to be a great buy setup among stock traders.
In the following article, the author will give readers a deep understanding about cup and handle pattern, from its formation, its role, to practical uses in the trading market.
What do you understand about the Cup and Handle Pattern?
The Cup and Handle pattern is another bullish continuation pattern, which means that an upside breakout to, or alternately of, higher prices is expected. The indicator is mostly utilized when analyzing the charts of stock prices but can also relate to other financial instruments like forex, commodities andcryptocurrencies among others.
The pattern consists of two main parts
- The Cup: This is a rounded, U shaped bottom that look a little like a bowl or a teacup. It depicts a stage when the volume of sales starts to reduce, and buyers slowly begin to dominate the market.
- The Handle: It is then pulled back either up or sideways to create the ”handle” after the cup body is shaped. It is also relatively short, which comes before a possible breakout above the resistance level at the top of the cup.
Anatomy of the Cup and Handle Pattern
To understand the pattern better, it’s essential to recognize its key components. Here’s a breakdown of each element:
| Component | Description | Significance |
| Cup | Rounded, U-shaped price movement | Indicates a period of accumulation and consolidation. |
| Left Side of Cup | Decline in price from a peak | Sellers dominate initially, causing a price drop. |
| Bottom of Cup | Lowest point of the pattern, usually flat or slightly rounded | Represents the point where selling pressure subsides. |
| Right Side of Cup | Gradual price increase toward the previous peak | Buyers return, causing a steady price rise. |
| Handle | Small pullback or consolidation near the top of the cup | Allows weak holders to exit before the breakout. |
| Breakout | Price movement above the resistance level | Confirms the bullish continuation signal. |
How to trade a Cup and Handle Pattern
Exactly the same as with every other pattern the first time one tries to find a cup and handle it is rather difficult, but as one masters the knack of it, it is relatively easy. Here are the key steps to follow when spotting this pattern on a price chart:
- Look for a Rounded Bottom: The bottom of the cup should have rounded edge, which should not contain any sharp corners. You should not get “V-shaped” bottoms because such patterns might have a different level of effectiveness.
- Check the Depth of the Cup: The depth of the cup should not be deep, in particular, it is insufficient to make it deeper than 30-50% to the previous high. Less cup depth shows that there is more optimistic bulls sentiment underlying the pattern.
- Watch for the Handle: After the cup is formed, anticipate the price to pull back, or consolidate, in the formation of the handle. The handle should ideally move back about 15-20% of the height of the cup on the bowl.
- Wait for the Breakout: The price should penetrate the inverted roof at the top of the cup. This area is characterized by an increase in trading volumes hence acting as confirmation of the breakout.
An example of the Cup and Handle Pattern
For instance, let us consider a particular stock that fluctuates between 100 and 70 dollars then down again to 100 dollars creating the left rim of the cup. The price then climbs back up to $100 to complete the right or the cup part of the graph. What follows is a small repetition channel, giving back some of the gains and setting the price around $95, which is the handle. Last but not the least; the price breaks above $100 which essentially is the breakout level and a buying opportunity.
How to trade the Cup and Handle Pattern
Traders can use the following strategy to trade the cup and handle pattern:
- Entry Point: Go short when you find that the price is reversed at the bottom and long when the price penetrates the upper cup-ceiling. This level is called the ‘buy point’.
- Stop-Loss Placement: Put stop loss just below the lowest point of the handle to prevent it from getting triggered in cases of fake breakout.
- Take-Profit Target: To determine the profit target, use the distance from the bottom of the cup to the level of resistance. It is appropriate to add this distance of the breakout point to estimate the price target.
Example:
- Resistance at $50, bottom of the cup at $40.
- The height of the cup = $50 – $40 = $10.
- Breakout point = $50.
- Price target = $50 + $10 = $60
Cup and Handle vs. Inverse Cup and Handle
The cup with handle is a bullish pattern, but the reversed pattern is bearish. The inverse cup and handle indicate the end of a bullish trend and therefore signals bearish market.
- Inverse Cup: Price forms a convex downward curve, differentiating the bullish spirit of the market from the bearish one.
- Inverse Handle: This is followed by a small rise before the breakdown gets to cause further price drops as it continues on its downward motion.
Common Mistakes to Avoid
- Misidentifying the Pattern: Not all ‘U-shape patterns’ as depicted in the graph above indicates a cup formation. Check correctly the shape of the handle, and the depth of the cup should be satisfactory.
- Entering Too Early: Do not get into a trade until the breakout has taken place. Early entrants may lead to more losses if the handle’s consolidation experience persists.
- Ignoring Volume: It will also expect more traffic at the breakout point of the chart. If the breakout does not have a volume confirmation it can be weak or flat out fail.
Real-World Example of the Cup and Handle
It is recommended to analyze the stock chart for a popular company, for instance Apple Inc (AAPL). Let us assume that it is reduced from $150 to $120, making the curved bottom part of the cup. It goes up again in the subsequent weeks reaching $150 to complete the cup formation. A little correction takes the price to $145 forming the handle. When price bar moves above $150 on volume, it is time to buy and which may as well achieve $170 or more.
Cup and Handle Pattern Summary
Pros:
- Allow for the definition of the entry point, the level of which the trader exits a trade and the level at which the trader takes profit.
- Active management can occur within the present, past and even the future as well as across securities within all classes of investment.
- It likewise works well together with other tools of technical analysis.
Cons:
- They can be relatively difficult to define, which is particularly true for newcomers.
- Losses occur when there are false breakouts.
- best worked it out when it takes weeks or even months before developing its pattern.
Conclusion
The cup and handle pattern is an excellent bullish continuation pattern for use by traders and investors. If the structure of the market is understood, its individual components are revealed, logically and properly trading techniques are applied it is possible to achieve higher probability of success. Always search for volume confirmation at breakout point and always set right stop loss and target to minimize risk.
Read More Blogs:)
