In the following article, we will discuss what is a cup and handle chart pattern and how to trade efficiently. We will also go over some FAQs about the cup and handle charts.
The Cup and Handle
To understand the fundamentals of the cup and handle trading, one must first understand the meaning of its pattern and how it works. The cup and handle pattern may be seen on short-term charts, like a one-minute, or a long-term chart, such as weekly charts. It happens when a stabilizing phase accompanies a declining price wave. Prices then see a recovery that matches the earlier slump amount.
Now let’s discuss the cup and handle formation. The phrase “cup and handle” resembles the shape of a ‘U’ or a ”cup”. The handle is formed as the price wanders down or travels laterally inside a channel. The handle might alternatively resemble a triangular shape.
The handle must be small in size in comparison with the cup. It should preferably remain in the top third and not fall into the cup’s bottom half. The handle must develop within $100 to $99.50, preferably within $100 and $99.65, assuming the cup, for instance, develops around $99 and $100. It would help if you refrained from trading this pattern when a handle sinks too far and wipes out most of the cup’s profits.
A cup and handle chart may indicate a continuing or reversing pattern. A reverse pattern develops when there is a long downward trend in the value. The pattern is subsequently changed, and the value rises as it forms a cup and handle. A continuing pattern develops throughout an uptrend: the prices increase, a cup and handle, and afterward, keep going up.
Note! As a trend is likely to persist, cup and handle patterns that appear towards its end must be disregarded.
Entering the cup and handle trade
Wait for the cup handle forms on the chart. It often has the shape of a lateral or descending channel or triangle. You should buy when the asset price – stock or crypto – breaks the top or triangle of the channel, i.e., the cup’s handle.
When the stock price breaks out of the cup’s handle, the pattern is considered complete, and the price is expected to rise. But that doesn’t mean it will. The price may increase slightly and then fall or drop right after entry; this is why a stop loss is necessary.
Setting a stop-loss
If the price falls rather than rises after buying on a breakout from a cup and handle formation, then a stop-loss order takes the trader out of the trade. It controls the risk of the trade by selling the position if the price falls enough to invalidate the pattern.
Set a stop-loss order underneath the handle’s lowest position. A stop-loss might also be positioned underneath the most current swing low if the value repeatedly increases and decreases inside the handle.
A correctly positioned stop-loss on the chart should not wind up in the bottom half of the cup formation because the handle must be in the top half of the cup. Consider a cup that develops anywhere from $60 and $59.50 as an example. The midway point of the cup means that the stop-loss must be over $59.75.
Both handle and stop-loss are placed in the cup’s top third (or upper portion), which keeps the stop-loss close to the point of entry and increases the trade’s risk-reward ratio. The target represents the reward portion, whereas the stop-loss represents the risk portion.
Note! Avoid the trade if the stop-loss goes lower than the cup’s midpoint. It needs to be at the top third of the cup, preferably.
Picking a target or profitable exit
Add the height of the cup to the handle’s breakout point, whatever that may be. It is the target. Assuming the breakout point is $90, and the cup develops between $90 and $89, the target becomes $91.
The left side of a cup may occasionally be taller than the right. Use a smaller height and add it to the breakout point for a conservative target; for an aggressive target, use a high altitude. Close the position before the market ends for the day if you are day trading and the target is not hit before the end of the day.
Note! Another way to exit a position that progresses toward the target but then begins to drop again is to utilize a trailing stop-loss.
At the cup’s bottom, there is typically a halt or stabilizing phase during which the price travels in a rounded or sideways pattern. It implies that the value found a level of support and could not go below it. It increases the likelihood that the price will rise after the breakout.
A V-bottom, in which the price falls and then suddenly rises, can also take the form of a cup. These cups are preferred by specific dealers while avoided by others. Those who favor them view the V-bottom as a rapid turnaround of the downward trend, demonstrating that buyers vigorously entered the favorable portion of the pattern.
The buy signal also benefits from the general trend when the cup and handle formation occurs in the middle of an upward trend. Look for a significant trend in this instance that is moving into the cup and handle. The bottom of the cup should match up with a level of longer-term support, like rising trend lines or moving averages, to provide extra assurance.
If the cup and handle appear to be following a downward trend, the trend may be about to change. Watch for the negative stock price movements to get smaller as they approach the cup and handle to increase the likelihood that the pattern will signal a reversal.
Note! The V-bottom’s critics contend that prices do not settle before bottoming and believe that the price could drop back to test that level. However, the price breaking above the handle finally denotes an upward movement.
Frequently Asked Questions (FAQs)
Here are a few commonly asked FAQs about the cup and handle chart pattern.
What happens after a cup and handle pattern?
A price move upward will occur when a cup and handle pattern is verified. The size of the cup has the potential to help one determine a price target, but what happens after the initial breakout from the cup and handle pattern is far less clear.
Take a closer look at the chart (for a longer period) to better understand what will occur following the cup and handle. Has there been a rise or fall in volatility? Is there an extended upward or downward trend? These broader contextual cues might be helpful if you want to retain positions further than the breakout.
How do you scan for a cup and handle pattern?
A cup and handle pattern cannot be found with a standard stock scanner setting, although it is simple to spot visually. You may browse the results until you locate a chart that resembles a cup and handle by setting your stock scanner to fit your other trading demands. A swing trader could look for equities that have done well recently, while a day trader may look for stocks with a relatively higher ATR.
The advantage of the cup and handle pattern is that it offers a favorable risk-reward ratio. However, when the market turns bullish, the inverted cup and handle trade will start to lose money. Before taking any action, it is usually advised to exercise caution and practice to make sure you are not making any mistakes.