What is a Cup and Handle pattern?
• The pattern resembles a cup with a handle, where the cup is in the shape of a “u” and the handle has a slight downward drift.
• This drop, or “handle” is meant to signal a buying opportunity. When this part of the price formation is over, the stock may reverse the course and reach new highs.
• It is a bullish continuation pattern i.e. it extends the existing uptrend
Parts of a Cup and Handle pattern:
The cup and handle chart has 3 main components:
1. Prior Trend: The cup and handle pattern is a bullish continuation pattern, hence the prior trend should be an uptrend.
2. Cup length: Generally, cups with longer and more “U” shaped bottoms provide a stronger signal. It should resemble a rounding bottom. This ensures that the cup is a consolidation pattern with valid support at the bottom of the “U”. The perfect pattern would have equal highs on both sides of the cup, but this is not always the case. Avoid cups with sharp “V” bottoms because there is almost no consolidation in that case.
3. Cup depth: Ideally, the cup should not be overly deep. In practice, the cup depth can be up to 60% of the last swing move. In my opinion, the best cups often have a depth of about 50% of the last swing.
4. Handle: Avoid handles that are overly deep also, as handles should not exceed 50% depth of the cup. The best cup and handle patterns have a shallow retracement on the handle (not more than 1/3 of the cup). However, in some situations, the price may retrace up to 0.618 Fibonacci level.
5. Breakout:Bullish confirmation comes when the pattern breaks above the neckline made using the prior highs with a good volume .
6. 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 make its move higher, back up to test the previous high.
7. Target: The profit target is equal to the depth of the cup. It can be measured by the distance between the bottom of the cup and the neckline and extending that distance upward from the breakout level.
8. Stop-loss: Ideally, the stop loss is placed at the lowest point of the handle. But if the price oscillated up and down a number of times within the handle, the stop-loss can also be placed below the most recent swing low.
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