A cup and handle is a technical chart pattern that resembles a cup with a handle. The cup is typically U-shaped, while the handle has a slight downward drift.

Fact to note: William J. O’Neil first defined and described the cup and handle pattern in his 1988 book, “How to Make Money in Stocks.”

Understanding the Cup and Handle Pattern

The cup and handle pattern is a technical chart pattern that resembles a cup with a handle. It is often used by technical analysts to identify potential buying opportunities in stocks.

Buyers’ strength over the sellers’ is always evident in this chart pattern. As the price falls and then rises to its original level, the cup forms.

The price dips again, but not as low, and rebounds strongly, forming the handle. This pattern indicates buyers’ resilience against selling pressure. The cup and handle pattern has two variations: continuation and reversal.

The continuation variant of this pattern appears where there is an uptrend. This pattern forms during a period of consolidation, followed by a breakout and a continuation of the upward trend.

While the reversal pattern indicates a possible trend reversal after a prolonged downward trend.

How to Identify the Cup and Handle Pattern

This chart pattern has two main parts:

The Cup: The cup is the first part of the pattern. It is a U-shaped formation that represents a period of consolidation or accumulation. The price may decline from a previous high, forming the left side of the cup. After reaching a low point, the price begins to rise, forming the right side of the cup.

The Handle: The handle is the second part of the pattern. It is a short-term downward price movement that follows the completion of the cup. The handle typically retraces a portion of the cup’s gains and is often characterized by lower trading volume.

Key Characteristics of the Pattern

• Symmetrical Shape: The cup and handle pattern is typically symmetrical, meaning that the left side and right side of the cup are roughly equal in length and depth.
• Volume: The volume of trading should decrease during the formation of the handle, indicating a period of consolidation or accumulation.
• Breakout: A successful cup and handle pattern is confirmed by a breakout above the resistance level formed by the handle.
• Formation Timeframe: The cup typically forms over 1-6 months or longer on larger charts. The handle ideally forms within 1-4 weeks or more, depending on the cup’s timeframe. Averagely, the pattern can form in as little as seven weeks or as long as 65 weeks.

Trading the Cup and Handle Pattern

Find the Entry Point

Traders often enter the market after the price breaks above the resistance level formed by the handle.

Identify handles that resemble lateral or descending channels or triangles. Buy when the price breaks above the channel or triangle’s top.

Once the price goes beyond the handle, anticipate an upward trend, although the price may fluctuate or take a sharp dip.

For risk management, stop-loss order can be placed below the handle to limit potential losses.

Set Stop-Loss

Place the stop-loss below the handle’s lowest point. If the price fluctuates within the handle, position it below the bottom of the most recent swing.

Preferably, position the stop-loss in the upper third of the cup and handle pattern. This proximity to the entry point in the upper third or half of the cup will enhance your risk-reward ratio.

Set Profit Targets

Profit targets can be based on technical indicators or price objectives, such as the height of the cup.

Conclusion

The cup and handle pattern offers several advantages. It serves as a reversal pattern, indicating a potential change in a stock’s trend. The pattern provides clear entry and exit points for easier trade management. Additionally, studies suggest a relatively high success rate for the cup and handle pattern.

However, the pattern also has limitations. Its identification can be subjective, with different traders interpreting it differently. Formation can be time-consuming, and there’s no certainty of completion.

Furthermore, the pattern may experience false breakouts, where it breaks above the handle but fails to maintain the upward movement.

While it is not foolproof, this pattern can provide valuable insights into market trends and help traders make informed decisions.

To see more chart patterns, explore our Forex glossary.