The Cup and Handle Pattern: Unleashing Your Trading Potential
A cup and handle price pattern on a security’s price chart is a technical indicator that resembles a cup with a handle, where the cup is in the shape of a “u” and the handle has a slight downward drift.
The cup and handle is considered a bullish signal, with the right-hand side of the pattern typically experiencing lower trading volume. The pattern’s formation may be as short as seven weeks or as long as 65 weeks.
Key Takeaways
- A cup and handle is a technical chart pattern that resembles a cup and handle where the cup is in the shape of a “u” and the handle has a slight downward drift.
- A cup and handle is considered a bullish signal extending an uptrend, and it is used to spot opportunities to go long.
- Technical traders using this indicator should place a stop buy order slightly above the upper trendline of the handle part of the pattern.
- The pattern was first described by William J. O’Neil in his 1988 classic book on technical analysis, How to Make Money in Stocks.
Credit: Image by Julie Bang © Investopedia 2020
Understanding the Cup and Handle Pattern
William J. O’Neil first defined the cup and handle (C&H) pattern in his 1988 classic, How to Make Money in Stocks. O’Neil provided detailed descriptions of the rounded lows that give the pattern its unique teacup appearance, along with measured time frames for each component.
When a stock forming this pattern tests old highs, it is likely to incur selling pressure, leading to a tendency toward a downtrend for a period of days to weeks, before advancing higher. A cup and handle is considered a bullish continuation pattern used to identify buying opportunities.
Consider the following when detecting cup and handle patterns:
- Length: Generally, cups with longer and more “U” shaped bottoms provide a stronger signal. Avoid cups with sharp “V” bottoms.
- Depth: Ideally, the cup should not be overly deep. Avoid handles that are too deep as well.
- Volume: Volume should decrease as prices decline and remain lower than average in the base of the bowl; it should then increase when the stock begins to rise back up to test the previous high.
A retest of previous resistance does not need to be exact; however, the further the top of the handle is from the highs, the more significant the breakout needs to be.
How to Trade the Cup and Handle
There are several ways to approach trading the cup and handle pattern, but the most basic is entering a long position.
Step-by-Step Trading Strategy
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Place a stop buy order slightly above the upper trendline of the handle. Order execution should occur if the price breaks the pattern’s resistance. However, aggressive entries may result in excess slippage or a false breakout.
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Alternatively, wait for the price to close above the upper trendline of the handle. Place a limit order slightly below the pattern’s breakout level, aiming to execute if the price retraces. This method carries a risk of missing the trade if the price continues to rise without pulling back.
Credit: Image by Julie Bang © Investopedia 2020
A profit target is determined by measuring the distance between the bottom of the cup and the pattern’s breakout level and extending that distance upward from the breakout. For example, if the distance between the bottom of the cup and handle breakout level is 20 points, a profit target is placed 20 points above the pattern’s handle. Stop-loss orders may be placed either below the handle or below the cup depending on the trader’s risk tolerance and market volatility.
Real-World Example: Trading the Cup and Handle
Consider a real-world example using Wynn Resorts, Limited (WYNN), which went public near $13 in October 2002 and rose to $154 five years later. The subsequent decline ended within two points of the initial public offering (IPO) price, marking a shallow cup. The recovery wave reached the prior high in 2011, almost a decade after the initial rise.
The handle demonstrated a classic pullback, finding support at the 50% retracement in a rounded shape, and returned to the high for a second time 14 months later. The stock then broke out in October 2013 and added 90 points in the following five months.
Credit: Image by Julie Bang © Investopedia 2020
Mastering the Cup and Handle: Limitations to Consider
Like all technical indicators, the cup and handle should be used alongside other signals and indicators before making a trading decision. Certain limitations exist:
- Timeframe: The pattern’s formation can range from one month to over a year, potentially leading to late decisions.
- Depth: The depth of the cup and handle varies, which may affect the reliability of the signal.
- Liquidity: The pattern may be unreliable in illiquid stocks.
Key Insights: Decoding the Cup and Handle
What Does a Cup and Handle Pattern Indicate?
A cup and handle pattern indicates a buying opportunity where the price movement of a security forms a “cup” followed by a downward trend handle. This setup suggests that the security may soon reverse course and reach new highs. Generally, cup and handle patterns range from seven weeks to over a year.
How Do You Identify a Cup and Handle Pattern?
A potential setup may occur when a stock corrects after reaching a high, dropping around 50%. An investor may purchase the stock anticipating a rebound to previous levels. The stock tests the previous high resistance and eventually surpasses these levels.
Post-Formation Expectations
Upon confirmation of a cup and handle pattern, a sharp price increase is expected in the short- to medium-term. Failure to form this pattern suggests that the expected bull run will not occur.
Setting Targets for Cup and Handle Pattern
The target is the height of the cup added to the breakout point of the handle, generally indicating bullish extension.
Bullish Signals: Is a Cup and Handle Pattern Bullish?
In general, cup and handle patterns are bullish formations. William O’Neil identified four stages: reaching a new high, retracing to a rounded bottom, rebounding to previous high and forming the handle, and finally breaking out surpassing the cup’s low depth.
Related Terms: uptrend, volume, resistance levels, stop-loss orders, breakout.
References
- William J. O’Neil. How to Make Money in Stocks. McGraw-Hill Education, 1988.
- BusinessWire. “William O’Neil + Company Announces the Passing of William J. O’Neil”.
- CMC Markets. “Cup and Handle Pattern”.
- U.S. Securities and Exchange Commission. “Wynn Resorts, Limited, Amendment No. 1 to Form S-3 Registration Statement, As Filed with the Securities and Exchange Commission on February 2, 2004”. Page 1.
- Wynn Resorts Limited. “Wynn Resorts, Limited Reports Third Quarter Results”.
- TradingView. “Wynn Resorts, Limited, WYNN”. Select Chart View All Time.
