Cup and handle pattern
Cup with handle pattern
The figure that we are going to know has a name that is at least curious: “cup and handle” and is a figure similar to the double bottom, but with the difference that in this case two valleys are formed, one of which is wider and the second smaller and with less depth.
The cup and handle is a pattern of bullish continuation that marks a period of consolidation followed by a breakout. It was developed by William O’Neil and introduced in 1988 in his book How to Make Money in Stocks.
The cup and hanlde pattern is a continuation pattern which means that can appear during an uptrend/downtrend and gives a signal of continuation of the trend. This pattern is formed by two rounded basses, the first being deeper and wider than the second one. The height of the cup and the handle are aligned along a straight horizontal line that acts as a resistance. This is the neck line of the cup and handle pattern.
Trend: To qualify as a continuation pattern, there should be a previous trend. The ideal trend should be a few months old and not too mature. The more mature the trend, the less likely the pattern is to represent a continuation and less likely to have upward potential.
Cup: The cup should be U-shaped and resemble the rounded bottom of a bowl. A “V” shape would be considered too aggressive. The “U” shape is softer and ensures that the cup is a consolidation pattern with valid support at the bottom of the “U”. The perfect pattern would have equal highs on both sides of the cup, but this is not always the case.
Handle: After the neckline (resistance) is formed on the right side of the cup, there is a recess that forms the handle. Sometimes this looks like a flag or pennant handle that leans down, other times it is simply short recoil. The handle represents the final consolidation, i.e., the retreat before the large break and can return up to 1/3 of the way up the cup, but usually no more. The smaller the handle, the more important the rise and break is. Sometimes it is prudent to wait for a break above the line resistance set by the highs of the cup.
Duration: The cup can extend from 1 to 6 months, sometimes more in the weekly charts. The handle can be from 1 week to several weeks and ideally completed in 1-4 weeks.
Volume: There should be a substantial increase in breakage volume above the handle strength.
Target: The projected progression after breakout of the neckline can be estimated by measuring the distance from the resistance of the cup to the bottom of the cup.
Several rules must be applied to validate this pattern formation:
- The cup with the handle must be preceded by a significant upward movement as mentioned before.
- The low point at the bottom of the cup must be less than 50% of the upward movement that precedes the formation (to confirm the uptrend).
- The low point of the handle must be less than 50% of the height of the cup to confirm the cup and handle figure.
The shape of the two lows (the cup and the handle) can lead to a rounded low that reflects the gradual depletion of the sellers. Buyers begin to take advantage once the neck line is broken (psychological threshold), and buying power becomes stronger and stronger.
The price target of this pattern is calculated by tracing a line from the lowest point of the cup to the neckline then we will place this line above the where the neck line is broken.
Some studies recommend use just half of the size of the cup as a target.
The graphical representation of the rate pattern with handle is as follows:
Statistics of the cup and handle pattern
- In 79% of the cases there is an upward break.
- In 73% of the cases, the price reaches the previously recommended target (half the height of the rate).
- In 74% of the cases, a pullback over the neck line occurs.
Notes on the pattern
The discoverer of this pattern, (OJ Neil) stated that the objective of the price increase is quite important so the trader should let the trade continue in order to take advantage of the whole movement. In fact, this formation is an important and highly reliable continuation pattern. The long term upside potential of the cup and handle is quite high.
It is advisable to wait for the pullback before opening a position.
If the cup has a lower left side than the right side, giving it an upward neck line, the performance of the pattern could be better.
However, pullbacks can have a negative effect on pattern performance.
Cup and Handle Trading Strategies
Classic strategy
Entry: A long position opens when the neck line is broken.
Stop: The stop loss is placed below the neck line.
Target: The theoretical target of the pattern is used.
Advantage: The target price of the pattern is often achieved (73% of the cases).
Disadvantage: Pullbacks are common (74% of cases)