Cup and Handle Key Points, & Examples
What is The Cup and Handle Pattern?
The “cup and handle” pattern is a widely recognized bullish signal in stock trading. This pattern emerges when a stock's price charts a cup-like shape, followed by a small downturn, known as the “handle.” Key characteristics of this pattern include:
- Formation of the Cup: The stock price creates a rounded, cup shape. The depth of this cup should be 12-35%.
- Development of the Handle: A slight dip follows, forming the handle. Crucially, the handle should not drop more than 15% below the cup's left high and should slope down, not up.
William O’Neil, a prominent technical analysis expert, first brought attention to this pattern. In his influential book, “How to Make Money in Stocks“, O’Neil highlights the cup and handle as a reliable indicator of bullish stock opportunities. He observed that stocks displaying this pattern often outperform the market in the following year.
Cup and Handle Pattern Rules
- A cup and handle pattern is a bullish continuation pattern.
- The cup should be rounded and resemble a U shape, not a sharp V.
- The pattern is formed over a minimum of 7 weeks. (Including Handle)
- The handle length is a minimum of 1 week.
- The pattern should form above the 200dma.
- Base depth should be 12-35%
- The handle should ideally slope downwards, not upwards.
Cup and Handle Pattern Trading Mistakes
When trading using the cup and handle pattern, it's crucial to avoid common pitfalls to maximize success. Two frequent mistakes are:
- Premature Buying: A key error is buying before the handle fully forms. The handle's ideal formation is no more than 15% below the cup's left high. If it dips lower, it could indicate the stock isn't ready for an upward breakout.
- Inadequate Risk Management: Despite the cup and handle pattern's reliability, it's not foolproof. Traders sometimes overlook the potential for failure, so it's essential to have a plan for such scenarios. Effective risk management is crucial in every trade, regardless of the pattern's historical reliability.
To help you manage your risk we've put together a free position size calculator you can use to help determine how many shares to buy based on your account size and trade parameters
Is The Cup and Handle A Bullish Pattern?
Yes, the cup and handle pattern is considered a bullish continuation pattern. Strong and high-performing growth stocks generally form cup and handle patterns during their bull runs. The forming of this pattern allows the stock to base or take a “breather” before its next move up and is seen as healthy action. Cup and handle patterns seen in bear markets are generally not as reliable.
The main reason for this is that bear markets are characterized by high levels of fear and uncertainty and investors tend to sell on any break-outs or rallies. This selling pressure creates a hard environment to gain traction after a cup and handle breaks out to the upside.
Remember, a cup and handle pattern signals a healthy rest after a prior uptrend. The prior uptrend is key. In a bear market, there is no such prior uptrend to provide a foundation for the pattern.
What Happens After a Cup and Handle Pattern?
After a cup and handle pattern forms, traders often anticipate certain movements in the stock:
- Potential Stock Movement: William O’Neil noted that stocks typically rise about 20-25% after forming this pattern. This observation sets an expectation for stock movement post-pattern formation.
- Handling Imperfections: The cup and handle pattern, while useful, is not infallible. Sometimes, the stock may not follow the expected upward trajectory.
- Risk Management Strategies:
- Using Stop-Loss Orders: Implementing stop-loss orders is vital. These orders can limit potential losses if the stock doesn't behave as predicted.
- Developing an Exit Strategy: Having a well-thought-out trading strategy for exiting is crucial. This plan helps manage situations where the stock doesn't increase as expected after the pattern.
Understanding the Cup and Handle Pattern Size Requirements
To be valid, a cup and handle pattern must meet specific size criteria. The ‘cup' part needs a 12-35% depth. This shows a notable, yet reasonable, retracement. The ‘handle' must develop within 15% of the cup's highest point. This indicates a slight and manageable pullback. Time is also key. The cup should take no less than 7 weeks to form, and the handle should take at least 1 week.
The Market Psychology of the Cup and Handle Pattern
The cup's bottom in this pattern marks a crucial psychological shift. It suggests a level where buyers begin to dominate over sellers, indicating a change in market sentiment. As the price recovers and forms the handle, approaching previous highs, investors who bought at these peaks often sell to break even. This leads to a temporary pullback in prices ‘the handle'. The handle represents the market's last effort to clear out uncertain holders, paving the way for more determined buyers to boost the stock's price.
A typical spot for this order is slightly under the handle's lowest point. This position safeguards against a false breakout or a failed pattern. It also allows the stock some movement within the handle's range.
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Cup and Handle Pattern Examples
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