Chart patterns are frequently used by traders to identify potential opportunities. While they aren’t as quantitative as technical indicators, they’re a visual way to trade at a glance and can be easily combined with other forms of technical analysis to provide actionable ideas.
In this article, we will take a look at how to identify and use the cup and handle pattern.
What Is a Cup and Handle Pattern?
The cup and handle pattern was introduced by William O’Neil in his 1988 book, How to Make Money in Stocks. The continuation pattern is formed when the price forms a rounded bottom, known as the “cup,” followed by sideways movement, known as the “handle.” A breakout from the handle’s trading range marks a continuation of the previous trend higher.
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The pattern can be identified with these rules:
- Prior Trend: There should be a prior trend higher since the cup and handle is a bullish continuation pattern as opposed to a reversal pattern.
- Cup: The cup should resemble a “U” rather than a “V” with roughly equal highs on each side of the cup. However, the price doesn’t necessarily need to uniformly follow the bottom of the “U” shape.
- Handle: The handle should form on the right side of the cup and often comes in the form of a “flag” or “pennant” that slopes downward. But in some cases, the handle can be a sideways price channel or even an ascending triangle.
- Breakout: The breakout should occur on higher-than-average volume to confirm the continuation pattern. Traders may also use other forms of technical analysis to confirm the breakout, such as a spike in the relative strength index.
How to Use the Cup and Handle Pattern
The cup and handle pattern, like most chart patterns, is relatively subjective in its interpretation.
In general, traders should look for a cup depth that’s no more than one-third of the previous advance and lasts between one and six months. The handle typically lasts between one and four weeks or about one-quarter of the cup’s duration. That said, day traders may use the pattern on much smaller timescales.
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The price target for the cup and handle pattern can be calculated by measuring the distance from the right peak of the cup to the bottom of the cup and adding that number to the breakout price point. Traders should also take into account other trend lines and resistance levels.
Stop-loss orders are often placed below the lowest point of the handle or below the most recent move lower. In other cases, traders may set a stop-loss at a certain percentage drawdown from the right side of the cup or below a trend line drawn along the right slope of the cup.
Traders should always use the cup and handle pattern in conjunction with other forms of technical analysis. For example, many traders pair the cup and handle pattern with Fibonacci levels to help set the ideal price targets, as well as place intelligent stop-loss points.
Examples of Cup and Handle in Action
Let’s take a look at the cup and handle pattern example in CIGNA Corp.’s (NYSE: CI) chart in 2018.
The cup was formed between February and August when CIGNA’s stock moved lower. The close of the gap from early March signaled the start of the handle. In this case, the stop-loss could be set at around $180.00 below the bottom of the handle.
The price target is equal to the difference between the low of $165.00 and the right peak of $180.00 – or $15.00 – applied to the breakout point of $190.00 – or $205.00. In early October, the price target was hit for a quick eight-percent profit in about 15 days.
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The Bottom Line
The cup and handle pattern is a great way to identify instances where a trend is poised to continue following a brief correction. Often, the pattern works best when used in conjunction with other forms of technical analysis, including technical indicators and other chart patterns.