What is a Cup and Handle Pattern in Trading?

A cup and handle pattern is one of the most popular candlestick patterns, which can be seen as a ‘U’-shaped curve. For inexperienced eyes, this pattern appears as a curve and a dip, but experienced traders recognise it as a cup and handle pattern.

This pattern indicates that the stock price will increase. This blog explores the handle and cup pattern and explains what it implies.

What is the Cup and Handle Pattern?

A cup and handle pattern was introduced by William J. O Neil in his book, ‘How to Make Money in Stocks’. The ‘U’-shaped curve in this pattern is followed by a slight downward drift, which appears like a teacup. This pattern suggests a continuation of an uptrend and indicates potential buying opportunities.

The pattern can take shape over 7 to 65 weeks, with the appropriate period being 3 to 6 months. Traders usually place a stop buy order just above the upper trendline of the handle, anticipating a breakout and a return to its previous highs.

What does a Cup and Handle Pattern Signal?

Since the stocks in a cup and handle pattern test old highs, they can face pressure from investors who have previously purchased the stock at this level. Most probably, it consolidates into a bearish trend between 4 days and up to 4 weeks before it moves upward because of the selling pressure. It is a type of bullish continuation pattern which is used to identify buying opportunities.

While finding a cup and handle pattern, consider these key aspects:

1. Shallowness

   You must prefer a shallower cup. In addition, the handle must not be very deep and should form in the upper half of the cup’s formation.

2. Duration

   A longer cup formation is usually more reliable, which is identified by a U-shaped base. It is recommended to avoid patterns of cups with some V-shaped bottoms.

3. Trading Volume

   When a price dips, trading volume may stay lower than average in the cup’s lowest point. Since the stock moves to its former peak levels, the trading volume will again increase.

How Does a Cup and Handle Pattern Take Shape?

A cup and handle pattern takes shape into two main parts, which are the cup and the handle:

1. Cup

   A cup in the pattern forms after a stock has gone up a lot, then fallen and bounced back up. This makes a cup shape on the chart. The appropriate cup shapes are like a long U, but not a sharp V, and must not be too deep.

2. Handle

   After the formation of a cup, the price will generally consolidate. This leads to a slight downward trend that takes the shape of a handle. This handle must be relatively short and should not go back than one-third of the cup’s height. The handle must form in the upper half of the cup pattern.

How to Trade With a Cup and Handle Pattern?

You must keep the following pointers to trade with a cup and handle pattern:

1. The cup must look like a normal U, and not a sharp V. This signals a stable uptrend from the lows.
2. A real breakout from the handle must come with noticeable trading volume.
3. You should consider that the stock price is strengthening for its next upward move, if the handle falls before breaking out the above resistance.
4. A cup and handle pattern must follow an uptrend, not just appear suddenly.
5. The depth of the cup is generally up to one-third of the pre-drop height. This takes about 1 to 6 months to form. The handle comparatively takes a shorter time, which is about 1 to 2 weeks, indicating a more cautious phase before the breakout.

These features can help you make wise trades after the handle’s breakout and set stop losses appropriately. This ensures placing more profitable trades.

However, traders who do not bother taking more risk can place their stop loss just at the bottom of the cup.

Benefits of the Cup and Handle Pattern

1. Precise Entry and Exit Points

   A cup and handle pattern provides clear entry and exit points, which is beneficial for traders to make accurate trades.

2. Volume

   The breakout confirmation with increased trading volume can enhance the pattern’s reliability. This provides extra confidence in the trade.

3. Bullish Continuation Signal

   A bullish continuation signal allows you to identify potential upward breakouts in ongoing trends.

4. Risk Management

   This pattern offers stop-loss levels just at the bottom of the handle.

Limitations of the Cup and Handle Pattern

1. Timeframe Considerations

   This pattern is generally reliable on long-term charts, and its impact might be diminished on shorter timeframes like intraday charts.

2. False Signals

   The breakout after the handle can fail in a volatile or weak market.

3. Subjective Shape

   It is also subjective to identify a perfect ‘cup’ and ‘handle’.

4. Not Always Reliable

   A cup and handle pattern needs volume confirmation and might not work well in sideways markets.

Final Thought

A cup and handle pattern helps you to identify bullish continuation in the stock market. This pattern indicates when to get prepared for an upward price movement. This allows traders to make more informed decisions and strategies to tap into the bullish momentum.

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Frequently Asked Questions

1. How accurate is the cup and handle candlestick pattern for predicting trends?

The accuracy of a cup and handle pattern is very wide. However, it is considered a reliable pattern when there is a high trading volume and proper market conditions. Therefore, you need a detailed statistical analysis to get precise success rates.

2. Is the cup and handle pattern bullish or bearish?

A cup and handle pattern is bullish, which helps to estimate the continuation of a prevailing uptrend. You can recognise it for its ‘cup’ formation, followed by a smaller ‘handle’. This handle indicates consolidation before a breakout.

3. What is the role of trading volume in confirming a cup and handle breakout?

Trading volume plays a pivotal role in confirming a cup and handle breakout. It indicates the power of buying interest. A healthy pattern shows a declining volume since the ‘cup’ forms, low volume in the ‘handle’ consolidation, and a surge in volume upon breaking out of the resistance level of the handle.

4. How much time does it take to form a cup and handle pattern?

A cup and handle pattern takes shape over 7 to 65 weeks, with the ideal period being 3 to 6 months.