Cup and Handle Pattern
tl;dr
The Cup and Handle pattern is a bullish chart pattern that signals a potential breakout to the upside after a period of consolidation. The pattern consists of a rounded “cup” followed by a smaller pullback or “handle.” When the price breaks above the resistance at the top of the cup, it suggests a new upward trend. Traders use the Cup and Handle to enter long positions after the breakout, with volume confirming the move. It’s a great tool for spotting long-term bullish trends.
Definition.
A technical chart pattern where the price forms a cup shape followed by a handle, signaling a potential breakout.
Real-World Example.
The Cup and Handle pattern is a bullish continuation chart pattern that resembles the shape of a tea cup, where the “cup” is a rounded bottom, and the “handle” is a smaller consolidation or pullback that occurs after the cup formation. This pattern suggests that after a period of consolidation (the cup), the price is likely to break out to the upside, confirming a new bullish trend.
For example, imagine you’re analyzing a stock like ABC Corp. The stock has been in a downtrend for several months but then begins to form a rounded bottom over time, which is the “cup.” After reaching the peak of the cup, the price pulls back slightly, creating the “handle.” Once the stock breaks above the resistance level formed at the top of the cup, this signals a bullish breakout, and traders may enter long positions expecting a price increase.
How the Cup and Handle Works.
- The Cup:
- The “cup” portion of the pattern forms after a downtrend. This is a gradual rounded bottom, and it usually takes several weeks or months to form. It indicates that the selling pressure has eased, and the asset is preparing for a potential reversal.
- Ideally, the depth of the cup should not exceed 30-50% of the previous price move to the downside.
- The Handle:
- After the cup has formed, the price will typically experience a slight pullback, creating the “handle.” The handle is usually a small consolidation or flag-like formation that occurs near the top of the cup.
- The handle typically takes a few days to a few weeks to form. It represents a pause before the price breaks out.
- The Breakout:
- The pattern completes when the price breaks above the resistance level at the top of the cup (the lip of the cup). This breakout signals that the price is likely to continue moving upward.
- Volume should increase significantly as the price breaks through the resistance level, confirming the strength of the move.
How to Use the Cup and Handle Pattern in Trading.
- Identify the Cup Formation:
- Look for a stock or asset that has been in a downtrend and is now forming a rounded bottom. The cup should be gradual and take several weeks or months to form. Avoid steep or V-shaped cups, as they do not fit the pattern well.
- Spot the Handle:
- After the cup is formed, a smaller pullback or consolidation should occur. This is the “handle.” The handle should be relatively shallow and often forms in the upper half of the cup. Avoid handles that are too deep, as they may indicate weakness.
- Look for the Breakout:
- Once the handle is formed, wait for the price to break above the resistance line at the top of the cup. This breakout confirms that the pattern is complete and the price is likely to continue moving higher.
- Volume is crucial—ensure that volume increases during the breakout, as this confirms the strength of the move.
- Set Entry and Exit Points:
- Entry: Enter the trade when the price breaks above the resistance level formed at the top of the cup.
- Target: The price target can be estimated by measuring the height of the cup and adding it to the breakout point. This can give you an approximate price level to target for your exit.
- Stop-loss: Place a stop-loss order just below the low of the handle to protect against potential downside.
- Use with Other Indicators:
- Combine the Cup and Handle pattern with other technical indicators like Moving Averages, RSI, or MACD to confirm the strength of the trend and avoid false breakouts. For example, an increasing RSI during the breakout can signal strong momentum.
