What Is a Cup and Handle Pattern?
The Cup and Handle security trading pattern is a bullish continuation pattern used in technical analysis. When the pattern appears on a stock chart, it shows a period of price consolidation followed by a price breakout. The pattern is called cup and handle because it has two distinct parts: the cup and the handle.
The cup pattern forms after an advance and looks like a bowl with a round bottom. It forms after a price advance. After that pattern forms, a “handle” forms to the right of the cup within a trading range. Finally, there is a breakout above the range of the handle, showing a bullish continuation of the prior advance.
Stock broker William O’Neil identified the cup and handle stock pattern and introduced it in his 1988 book, How to Make Money in Stocks.
How the Cup and Handle Works
The cup-and-handle candlestick pattern starts with the formation of the “cup, which looks like a bowl. The two sides of the cup are not always the same height but in a perfect scenario they would be. Once the cup forms, the stock price pulls back, forming a “handle” out to the right of the cup. The handle shows price consolidation happening before a price breakout occurs.
The handle is smaller than the cup and generally doesn’t retrace more than ⅓ of the cup’s advance, staying in the upper part of the cup range. It can also form a triangle shape. If the handle forms at the bottom price range of the cup, the pattern may indicate that this is not a good time to trade. It may take six months or longer for the cup pattern to form, but the handle forms much faster, ideally within four weeks.
The entire pattern can also form within minutes or days. Technical analysts watching the cup-and-handle pattern try to buy when the price breaks out from the handle. This is marked by when the price moves above the old resistance level, which is the top of the right side of the cup. The more volume in the breakout the stronger the buy signal.
To estimate the price target the stock might hit after the breakout, a trader would measure the distance from the bottom of the cup to the top of the right side of the cup and then add that number to the buy signal point. If the left and right sides of the cup are different heights, the smaller side would give a more conservative price target, and the taller would be a more aggressive target.
What Does a Cup and Handle Pattern Tell Traders?
The cup-and-handle is a candlestick pattern that indicates a cup-shaped price consolidation. This involves a downward price movement, a stabilization period, then a price increase of about the same amount as the downward movement.
This is followed by a sideways pullback between the high and low of the cup shape, forming the handle. Then, a price breakout indicates increasing trade volume. However, as with any trading pattern, a cup-and-handle pattern does not guarantee the stock price will continue on a bullish trajectory, it’s just a trading indicator.
The cup and handle is a bullish pattern that can show a continuation or a reversal from a bearish trend into a bullish trend. Either way it indicates that the stock price will likely rise following the pattern.
Example of a Cup and Handle Pattern
An example of a cup and handle pattern would be if a cup shape forms between $48 and $50. A handle should then form between $49 and $50, ideally closer to $50. Then the price should break out above the price range of the handle.
Does the Cup and Handle Pattern Work?
The cup-and-handle pattern is one strategy that traders can use to get a sense of the market and inform their investing decisions. However, it is not a perfect tool.
Like any trading pattern, the cup and handle should be used in conjunction with other trend indicators and signals to make informed trading decisions. Although the cup and handle pattern can be a useful and easy to understand pattern to find entry and exit points, it does have some drawbacks.
The cup-and-handle pattern may form over the course of a day, weeks, months, or even a year. This makes it challenging to figure out exactly when to place a purchase order. Generally it forms over a month to a year, but identifying the exact breakout point is not easy.
Also, the depth of the cup can be a confusing part of the pattern. A shallow or a deep cup might be a false signal. The cup also doesn’t always form a handle at all, and the liquidity of the stock also affects the strength of the trading signal.
How to Trade a Cup and Handle Pattern
Traders wait for the handle pattern to form, which may either be in the shape of a sideways handle or a triangle. When the stock price breaks out above the top of the handle, that indicates completion of the cup-and-handle pattern, and creates a signal that stock price could continue to rise.
Although the cup-and-handle pattern can be a strong buy indicator, it does not guarantee that prices will go up. The stock price may rise, fall again, then continue to rise. Or it might rise and then simply fall.
One way to avoid significant losses when this happens is to set a stop-loss on trades with your broker. Day traders may want to close out the trade before the market closes.
Cup-and-Handle Patterns in Crypto
While the cup-and-handle pattern has traditionally been used for stock trading, it can also be used in crypto trading. Cup and handle patterns have formed in Bitcoin and Ethereum charts in recent years. Bitcoin formed a cup and handle pattern in 2019, and Ethereum formed one in 2021. The basic guidelines and indicators are the same for crypto as for stocks.
Stock patterns are signals that form a certain recognizable shape when charted graphically, making them easy to spot and trade. They can help traders find entry or exit points, estimate price targets and potential risk. The cup-and-handle pattern is a useful and easy to follow trading pattern to help traders spot entry points for bullish trades.
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