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Trading Indicators & Tools

Cup and handle pattern: how to trade it

Cup and handle pattern: Bitcoin and gold price chart displaying a cup and handle pattern.

Just as the name suggests, the cup and handle pattern resembles an actual cup with a handle. This technical analysis chart pattern is a bullish signal that occurs regularly in financial markets. It signifies a possible continuation or reversal of an uptrend and, for traders who can spot it, it could be a lucrative entry or exit point. Keep reading to learn how it works in trading.

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What does cup and handle mean in technical analysis?

The Cup and Handle pattern is a bullish technical analysis chart pattern that signals a potential upward trend or trend continuation in financial markets. Named after its distinctive shape, this pattern consists of a 'cup' - a U-shaped pattern that represents a period where the market consolidates or builds a base after a significant downtrend, and a 'handle' - a short period of consolidation or a slight downward drift.

The pattern is considered complete when prices break out above the resistance line of the handle, signalling a potential bullish run. This breakout point acts as the buy trigger for traders.

While the origins of the Cup and Handle pattern are unclear, it was popularised by William O'Neil in his writings. O'Neil, who also founded Investor's Business Daily, utilised this pattern as part of his investment strategies and brought it into mainstream use. However, it's worth noting that this pattern was already a part of the trader's toolkit before O'Neil's work and has its conceptual roots in earlier trading practices.

How do you identify a cup and handle pattern?

Identifying a Cup and Handle pattern involves recognizing two key components: the 'cup' and the 'handle'.

  1. The cup: Picture a tea cup on a table. The left side of the cup starts at the high point where the price was before it started going down. The bottom of the cup is the lowest point the price reached, and the right side of the cup is where the price starts going back up to around the same high point as the left side. This makes a U shape, or the 'cup'. The drop and rise should be smooth, not a sudden drop or rise.
  2. The handle: Now imagine a small downward slope on the right side of the cup. That's the handle. It forms when the price drops a bit after reaching the high point of the right side of the cup, but not by much - no more than a third of the height of the cup.

The pattern is considered valid if the 'handle' part doesn't drop more than half the depth of the 'cup' part.

Keep in mind this pattern takes time to form - usually best seen on a weekly or monthly price chart. And watch how many trades are happening (the volume). More trades should happen during the 'cup' formation and fewer during the 'handle' formation.

Lastly, take note of the Resistance Level. This is the highest price level that the stock reaches before falling back down. If the price breaks through this level (goes higher), it's a strong sign that the price might keep going up.

What are the types of cup and handle patterns?

  1. Cup and odd handle: This is when the 'cup' part of the pattern forms as expected, but the 'handle' looks a bit different than usual. Maybe it's longer than expected, or maybe it dips down further than we'd like. But even if the handle seems a little strange, traders will still watch it closely. If the price starts to rise again and breaks past the top of the handle, it could be a good sign that the price will keep going up.
  2. Multi-Year cup and handle: This one is just like it sounds - a cup and handle pattern that takes multiple years to form. The 'cup' might form over one year, two years, or even more. Then, the 'handle' might form over the next several months or even a year. Because this pattern takes so long to form, it can signal a very strong trend when the price finally breaks above the handle. It's like a slow, steady drumroll leading up to a big announcement.
  3. Intraday cup and handle: This is a cup and handle pattern that forms within a single trading day. It's a fast-paced version of the pattern, where the 'cup' might form over a few hours in the morning, and the 'handle' might form in the afternoon. Traders who spot this pattern might expect a price increase before the end of the day.

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Advantages and disadvantages of cup and handle pattern

Advantages: Disadvantages:
Easy to identify: The cup and handle pattern is visually straightforward, resembling the shape of a tea cup with a handle on the right side. This makes it one of the easier patterns to spot on a chart. Subjective interpretation: The cup and handle pattern can be open to interpretation. What one trader sees as a valid pattern, another might not. This subjectivity could lead to missed opportunities or false signals.
Risk management: The pattern provides clear points for stop-loss and take-profit levels. The stop-loss could be placed below the lowest point of the handle, and the take-profit level could be the same distance from the breakout point as the depth of the cup. False signals: Like all technical analysis patterns, the cup and handle could give false signals. A seeming breakout could reverse, leading to losses.
Volume confirmation: The pattern usually forms with high volume at the start of the 'cup' formation and decreases during the 'handle' formation, then picks up again during the breakout. This change in volume could confirm the pattern. Requires experience: While the pattern is relatively easy to identify, interpreting it correctly and making profitable trades based on it requires experience and skill.
Long-term trend: The cup and handle pattern often signals a continuation of a bullish trend. It's especially reliable when it forms during an uptrend, indicating a long-term positive movement. Time-consuming: The pattern can take a long time to form - weeks, months, or even years. Traders need patience to wait for the pattern to complete before making a trade.
Market risk: Despite the pattern's reliability, unexpected market events could disrupt the pattern and lead to losses. Even the most reliable patterns can't predict or account for sudden market changes or news events.
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How to trade cup and handle pattern?

  1. Spotting the pattern: The first step is to identify the cup and handle pattern on the price chart. This pattern looks like a cup with a handle on the right side. The 'cup' is a U-shaped curve and the 'handle' is a smaller curve.
  2. Checking the volume: You need to check how many trades are happening. Usually, there are more trades when the 'cup' forms and fewer trades during the 'handle'. If you see this happening, it might confirm that the pattern is valid.
  3. Setting a stop loss: This is like setting a safety net to limit your potential loss. If you're wrong and the price starts to fall, the stop loss will automatically sell your position at a certain level. For the cup and handle pattern, this is usually set just below the lowest point of the 'handle'.
  4. Setting a profit target: This is deciding ahead of time at what price you'll sell for a profit. You can calculate this by adding the depth of the 'cup' (the distance from the top of the 'cup' to the bottom) to the price level at the top of the 'handle'.

Summary

Remember, while the Cup and Handle pattern can be a useful tool for predicting possible price movements, it's not always 100% accurate. Other factors can also affect the price, so it's always a good idea to consider other market trends and news. And most importantly, never risk more money than you're comfortable losing.

Want to learn more trading chart patterns for free? Visit the Skilling education center today by clicking here.

This article is offered for general information and does not constitute investment advice. Please be informed that currently, Skilling is only offering CFDs.

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