Table of Contents:
- Cup and Handle Pattern Examples
- How to Identify a Cup and Handle Pattern
- Cup and Handle Limitations
- Cup and Handle Trading Tips
- The Bottom Line
As you learn more about investing and how stocks work, you’ll discover that there is a lot of strategy involved that helps in the quest to make more educated decisions in choosing your investments, with indicators and patterns showing to have a lot of value.
As you might expect from the name, the cup and handle chart is a technical indicator that looks like a cup with a handle. The cup is a U shape, with the bottom of the cup having a rounded bottom and a handle that forms to the right in a slightly downward direction.
It’s considered a bullish signal, indicating prices are rising, which offers opportunities to go long (for a reminder on the nuances of bull vs bear, check out this article). The cup and handle formation time frames are approximately seven weeks to a year.
- A cup and handle technical pattern looks like a teacup with a handle with the cup in the shape of the U and the handle extending in a downward direction on the right side.
- A cup and handle pattern is considered a bullish signal extending an uptrend in the stock market and is used to discover the opportunities to go long.
- Along with the cup and handle pattern, there are a variety of additional investment strategies.
Cup and Handle Pattern Examples
The creation of the cup and handle formation occurs when a stock price falls but then moves back up to the point where the decline began.
The philosophy surrounding the cup and handle pattern refers to the idea that if the stock price declined and rebounded, it could be due to a positive sentiment leading investors to buy.
Looking at the cup and handle pattern, you can see why it’s considered bullish, as the U pattern leads upward. But what’s even more important is where the price moves after the pattern is formed, which shows whether it will continue to rise above the handle moving to a bullish market.
There are also bearish patterns called the inverted cup and handle, also referred to as reverse cup and handle. It’s an upside-down cup with a handle that is angled downward, which forms when there is a drop followed by a rebound up and then another drop.
A break below the handle may mean we are moving into a bearish market, as investors look to exit their long position and move to a short position. Setting a stop-loss order above the handle can assist in controlling risk if the price declines, outside the pattern.
How to Identify a Cup and Handle Pattern
There are various indicators to watch for to identify a cup and handle pattern. In his book, How to Make Money in Stocks, William J. O’Neil discusses the importance of reading charts. For example, in the section of the book on the cup and handle pattern, he describes indicators and states that the handle pattern should extend about one-fifth to one-quarter of the length of the cup.
Additionally, when looking for the pattern, it can be helpful to consider factors such as:
- Length — a longer U shape bottom can indicate a strong signal. In contrast, the V shape bottom is connected to a weakened signal and should be avoided.
- Depth — the cup should represent a teacup rather than a deep mug, with a handle formed at the top section of the cup.
- Volume — as prices decline, the volume should decrease and stay low at the base of the cup until the stock rises and goes back to the previous high point.
Together with additional indicators, the cup and handle chart pattern can be a valuable tool in determining how to invest in stocks.
Cup and Handle Limitations
Technical indicators and signals are valuable assets in making investment decisions. Still, like anything else, the cup and handle pattern charts work best when combined with additional indicators. Although it’s one of the more popular chart patterns, it also has limitations.
- The cup and handle can take time to complete, which may lead to hesitation in decision-making, resulting in late decisions.
- Depending on the depth of the cup, with a shallow cup being a signal, if it’s too deep, it may represent a false or ambiguous signal, making decision-making difficult.
- Occasionally the cups will form without a clear handle, leading to questions about whether it’s a false signal.
- Although it’s a valuable tool, it may not always be reliable.
Cup and Handle Trading Tips
In learning how to use the cup and handle pattern, it’s important to understand that when the handle is formed, investors may place a stop buy order just above the top of the trendline, with the execution of that order occurring when the price breaks from the pattern.
When the price closes above the trendline, investors may choose to place a limit order just below the breakout level in hopes of executing the order if the price backtracks.
When setting a profit target, investors determine the distance between the cup’s bottom to the pattern’s breakout level and, depending on risk tolerance, place a stop-loss order below the handle or the cup.
As discussed earlier, William J. O’Neil defined the technical components of the cup and handle pattern and offered detailed descriptions of how to use it in his book, How to Make Money in Stocks.
Along with that information, he included four stages in a cup and handle breakout to identify. They are:
- Identify the stock’s significant uptrend as it rises.
- When a pullback occurs, it forms a rounded bottom that is no deeper than 50% of the retracing showing the pattern of the cup.
- Another uptrend doesn’t reach the last high point so the stock price levels off or dips slightly, forming the handle.
- Another breakout occurs and brings the stock price to a new high that sets it at the previous high plus the depth of the cup.
Plenty of investors choose to follow the cup and handle stock rules of O’Neil strictly, but there are a variety of additional investment strategies like that as well.
The Bottom Line
The cup and handle pattern shows that a stock can be at a high, then dip and stabilize and then rise again, offering investors a pattern that, when appropriately identified, can be a beneficial strategy in an overall volatile stock market.
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