The cup and handle chart pattern is one of the more obvious candlestick patterns when it takes shape. So, if you struggle as a new trader identifying candlestick patterns, this one is easy!
Whether you are a day trader, swing trader, or do long-term investing, candlestick patterns can tell a story and provide clues as to where the price may be heading. When analyzed correctly, this can be beneficial to any trader when combined with good strategy!
Many traders rely on technical analysis, such as a chart pattern, or a favorite technical indicator to help them assess market conditions. These trading tools can help them understand price moves, price breaks, price trends, and the overall market beliefs of the bulls and bears before entering a trade.
In this article, we will discuss the cup and handle, which is a bullish continuation pattern that looks just like its name. Seriously, look in your kitchen cupboard! Grab a cup and let’s converse about it!
What Is a Cup and Handle Pattern
The cup and handle pattern is a technical chart pattern that provides a bullish signal. Bullish means an increase in value or price whereas bearish means a decrease.
It was defined by William O’Neil in his 1988 book “How to Make Money in Stocks”. So, it has been around for quite some time and relied upon for years now.
The bullish continuation pattern of the cup and handle means it upholds the previous uptrend and provides buying opportunities for traders.
How Is the Cup and Handle Created
Typically, before the cup and handle pattern forms, there will be an uptrend that retests previous highs and a historical level of resistance. Once these old highs are reached, the market will most likely incur selling pressure.
The price will then drop and flatten out some moving more sideways. Price action consolidates and volume appears lower than average. Once consolidation takes place, a rise in buying occurs up to the original value of resistance. This is how the cup forms.
A small retracement then occurs with a breakout level which can be identified as the handle formation.
The cup and handle pattern can be used in various time frames, but the long term tends to be 1 to 6 months for the cup formation and 1 to 4 weeks for the handle pattern. A lower time frame may present the pattern, but some traders believe the reliability is more significant in longer time frames.
What Does a Cup and Handle Pattern Look Like
The cup and handle pattern resembles a teacup-like shape and is more significant when it forms following an increase in price trend.
The cup pattern should look fairly shallow with a slightly flat or rounded bottom. The price trend will test a previous high, selling pressure comes in and lower volume occurs. Typically, a trader will see the price drop and consolidate.
This area of consolidation creates support and the bottom of the cup. The cup part should be more of a “U” shape versus a “V” to be a more valid cup pattern.
A trader will then notice the price breaking above consolidation levels because of an increase in buying pressure. Higher volatility comes in, and price rises back up, or close to, the previous high which concludes the cup pattern.
Once the right side of the cup is equal to or close to being equivalent to the left side, the cup is considered complete.
If you are looking at a price chart, the handle part of the pattern, or small pull back, typically faces the right hand side.
The handle formation should only be the top half of the cup formation or less. For the best signal, handle patterns should only be 30% to 50% of the rise at the end of the cup pattern.
Below is an illustration of a cup and handle pattern to give you an idea of its appearance.
How to Trade Using the Cup and Handle Pattern
Before trading the cup and handle pattern, confirm its characteristics and prior direction before it formed. Go through this brief checklist of key attributes:
What was the prior trend before the cup pattern formed?
Does the cup resemble more of a “u” or “v” shape?
Did the cup part retest historical resistance levels?
Is the handle less than one-half, ideally only one-third or less of the cup?
Although it is visually easy to recognize, notice its attributes to analyze if it is a significant pattern.
It is also important to use other forms of validation as well. Some traders use technical indicators such as Fibonacci levels to trade the pattern or other forms of analysis to validate the pattern’s price direction like an EMA which is a moving average.
The cup and handle pattern usually signals a bullish continuation. Given this, a trader would be looking to take a long position or an option call expecting the price to rise.
When planning your trade entry using the cup and handle, wait for the handle pattern to form. The handle part should create a descending channel.
Once again, make sure the handle isn’t too deep of a retracement; you want it to be only the top half of the cup pattern or less.
A trade entry point would be a breakout level above the channel in the handle pattern.
Experienced traders know that the market can be unpredictable due to the vast number of participants. It can go up, sideways, or down at any time.
This is why it is important to not only plan your entry point but also have a set exit strategy. Like all trades, your exit plan should include a stop loss and a take profit target.
When trading the cup and handle pattern, a suggested stop loss order would be just below or at the lowest point of the handle.
A suggested take profit level would be the height of the cup pattern added to the breakout point. If one side of the cup is slightly different in height, use the smallest area as a take-profit reference.
Summary: Cup and Handle
The cup and handle pattern is typically a bullish continuation candlestick pattern that retests previous areas of resistance. Most traders believe it has more relevance in higher time frames than lower when it forms.
Key takeaways would be to look for characteristics such as a flat, or rounded cup bottom and a handle that only retraces the top portion of the cup.
Like with all chart patterns, be sure to seek additional confirmation to determine the significance of the cup and handle before trading. Take the time to practice and backtest the use of the pattern in a simulated environment before trading with real money.
Trading the financial markets carries risk. The possibility of a false signal can occur. In the case of a false breakout, know your risk tolerance. Having a planned price target to take profit as well as an exit plan should always be a part of a trader’s winning system!
Maurice Kenny has helped over 600 people become financially free through one-on-one coaching, mentorship, and options trading strategy. Many of these new traders are now full-time traders, and they all started by watching his 1-hr webinar.
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