Understanding and Using Cup and Handle Patterns
A technical signal that resembles a cup with a handle—where the handle has a small downward drift and the cup is shaped like a “u”—is called a cup and handle price pattern on the price chart of an asset.
The cup and handle pattern is seen as a bullish indication, and lesser trade volume is usually seen on the right side of the formation. The creation of the pattern might take up to 65 weeks, or as little as seven weeks.
In his 1988 book How to Make Money in Stocks, American expert William J. O’Neil established the cup and handle (C&H) pattern and added technical criteria in a series of articles published in Investor’s Business Daily, which he started in 1984. In addition to providing time period estimations for each element, O’Neil provided a thorough explanation of the rounded lows that give the pattern its distinctive teacup shape.
When a stock forms this pattern and tests previous highs, investors who bought at those levels are likely to sell it. This selling pressure will likely cause the price to consolidate for four days to four weeks, with a tendency toward a downward trend, before rising higher. A cup and handle pattern, which is used to detect purchasing opportunities, is seen as a bullish continuation pattern.
When looking for cup and handle patterns, the following should be taken into account:
• Length: Generally speaking, a stronger signal is produced by cups with longer, more “U” shaped bottoms. Avert cups with acute “V” shaped bottoms.
• Depth: The cup should ideally not be very deep. Additionally, avoid too-deep handles, as handles should form in the upper portion of the cup design.
• Volume: When prices drop and stay below average in the bowl’s base, volume should go down. When the stock starts to rise upward, it should go up again, testing the prior high.
It’s not necessary for a retest of prior resistance to touch or come within a few ticks of the previous high; yet, the more distance the top of the handle has to go from the highs, the more substantial the breakout must be.
How to Trade the Cup and Handle
Trading the cup and handle may be approached in a number of ways, but the simplest is to search for opportunities to establish a long position. This picture below shows a traditional cup and handle arrangement. Put a stop buy order just above the handle’s upper trend line. Only when the price breaks the resistance of the pattern should an order be executed. Traders may use an aggressive entrance to enter a false breakout and endure excessive slippage. Types of Chart Patterns may be applied to line, bar, and candlestick charts and can be based on seconds, minutes, hours, days, months, or even ticks.
The distance between the pattern’s breakout level and the cup’s bottom is measured, and that distance is extended upward from the breakout to set a profit goal. A profit target is set, for instance, 20 points above the pattern’s handle if the gap is 20 points between the cup’s bottom and the handle breakout level.
Trading the Cup and Handle, for instance
Now, let’s look at a historical real-world example utilizing Wynn Resorts, Limited (WYNN), which went public in October 2002 at a price of about $13 on the Nasdaq market and increased to $154 five years later.23 Although O’Neil had required a shallow cup high in the previous trend, the ensuing downturn finished within two points of the IPO price.
Constraints on the Cup and Handle Design
Before making a trading decision, the cup and handle should be analyzed in conjunction with other signals and indications, just like any other technical indicator. Practitioners have specifically noted a few restrictions with the cup and handle. First, it may take some time for the pattern to completely develop, which might cause judgments to be made after the fact.
A deeper cup may provide a misleading signal, although a shallower cup may occasionally be a signal. There are instances when the cup develops without a recognizable handle. Last but not least, a drawback common to many technical patterns is that they can be unpredictable in illiquid equities.
A technical signal known as a “cup and handle” occurs when a security’s price movement resembles a “cup” and is followed by a downward trending price pattern. This decline, also known as a “handle,” is intended to indicate a chance to purchase a security and go long. The security may reverse direction and hit new highs after this phase of the price development is over.
Imagine a situation where a stock recently had strong momentum lead it to a peak, but it has now corrected, dropping over 50%. An investor could buy the stock at this time in the hopes that it would rise to earlier levels. After hitting the prior high resistance levels, the stock eventually recovers and enters a sideways trend. The stock breaks through these resistance levels in the last leg of the pattern, rising 50% above the prior high.
Cup and handle patterns are often bullish price structures. William O’Neil, the term’s originator, separated this technical trading pattern into four main phases. One to three months prior to the start of the “cup” pattern, security will first experience an uptrend and hit a new high. Second, there will be a retracement of the security, with a minimum 50% loss from the previous high, resulting in a rounded bottom. Third, to create the “handle” portion of the formation, the security will rise to its prior high before declining. At last, the security breaches once again, transcending its peaks to the extent of the cup’s lowest point.