How to trade and target with an example

What is a cup and handle pattern?

A cup and handle price pattern on a security’s price chart is a technical indicator that looks like a cup with a handle, where the cup is in the shape of a “u” and the handle is a slight have downward drift.

The cup and handle is considered a bullish signal, with the right side of the pattern typically experiencing lower trading volume. The pattern’s formation can be as short as seven weeks or as long as 65 weeks.

What does a cup and handle pattern tell you?

American technician William J. O’Neil defined the cup and handle (C&H) pattern in his 1988 classic, How to Make Money in Stocks, and added technical requirements through a series of articles published in Investor’s Business Daily, which he founded in 1984. Neil has included time frame measurements for each component, as well as a detailed description of the rounded lows that give the pattern its unique teacup look.

As a stock forming this pattern tests old highs, it is likely to cause selling pressure from investors who previously bought at those levels; selling pressure is likely to consolidate price with a trend towards a downtrend for a period of four days to four weeks, before advancing higher. A cup and handle is considered a bullish continuation pattern and is used to identify buying opportunities.

It is worth considering the following when locating cup and handle patterns:

Length: In general, cups with longer and more “U” shaped bottoms provide a stronger signal. Avoid cups with sharp “V” bottoms. Depth: Ideally, the cup should not be too deep. Also avoid handles that are too deep, as handles should form in the upper half of the cup pattern. Volume: Volume should decrease as prices fall and remain below average in the base of the bowl; it should then increase when the stock begins to make its move higher, backing up to test the previous high.

A retest of previous resistance is not necessary to touch or come within several ticks of the old high; however, the further the top of the handle is from the highs, the more significant the breakout should be.

How to trade and handle the cup

There are several ways to trade the cup and handle, but the most basic is to look for a long position. The image below depicts a classic cup and handle shape. Place a stop buy order slightly above the upper trend line of the handle. Order execution should only occur if the price breaks the resistance of the pattern. Traders can experience excessive slippage and enter a false breakout by using an aggressive entry.

Alternatively, wait for the price to close above the upper trendline of the handle, then place a limit order slightly below the pattern’s breakout level, and try to get an execution if the price falls back. There is a risk of missing the trade if the price continues to advance and does not pull back.

A profit target is determined by measuring the distance between the bottom of the cup and the pattern’s breakout level and extending that distance upward from the breakout. For example, if the distance between the bottom of the cup and the breakout level of the handle is 20 points, a profit target is placed 20 points above the pattern’s handle. Stop-loss orders can be placed either below the handle or below the cup, depending on the trader’s risk tolerance and market volatility.

Example Trade the cup and handle

Now let’s look at a real-life historical example with Wynn Resorts, Limited (WYNN), which debuted on the Nasdaq stock market at nearly $13 in October 2002 and rose to $154 five years later. The subsequent decline ended within two points of the initial public offering (IPO), far exceeding O’Neil’s requirement for a shallow cup high in the previous trend. The subsequent wave of recovery reached the previous high in 2011, almost 10 years after the first push.

The handle follows the classic pullback expectation, finds support at the 50% retracement in a rounded shape, and returns to the high for a second time 14 months later. The stock broke out in October 2013 and added 90 points in the next five months.

Limitations of the cup and handle pattern

Like all technical indicators, the cup and handle should be used in conjunction with other signals and indicators before making a trading decision. Specifically, with the cup and handle, certain limitations were identified by practitioners. The first is that it can take some time for the pattern to fully form, which can lead to late decisions. Although one month to one year is the typical time frame for a cup and handle to form, it can also happen quite quickly or take several years to establish itself, making it ambiguous in some cases.

Another issue has to do with the depth of the cup part of the formation. Sometimes a shallower cup can be a signal, while other times a deep cup can produce a false signal. Sometimes the cup forms without the characteristic handle. Finally, one limitation shared across many technical patterns is that they can be unreliable in illiquid stocks.