Profit-making opportunities: Recognising Cup and Handle Pattern

In the complex world of trading, patterns hold significant meaning as their formation represents the sentiments of the traders. Understanding and recognising these stock chart patterns can be the difference between a bullish or a bearish trade. One such pattern is the cup-and-handle pattern (C&H), which has helped investors recognise profit-making opportunities for decades.

William J. O’Neil, an American technical analyst expert, first described this pattern in his 1988 classic, How to Make Money in Stocks. He defined the cup-and-handle pattern as a bullish chart pattern that is identical to a cup with a downward angle, mimicking a handle. He observed that stocks that displayed such patterns almost always outperformed the market in the following year. 

Simply put, the C&H pattern forms when the price of an asset falls but, over time, rises back to the point where the fall began. This pattern can be seen in all sorts of trades, like commodities, currencies, and stocks. If you are new to this side of the world or are just looking to refresh your memory on stock breakout patterns, sit tight as we explain everything that you need to understand about what is a cup and handle pattern, how to spot them, and their characteristics.

Identifying the Pattern

Identification of any pattern depends on several factors that are:

1. Length: The duration during which a pattern is formed. It can be days, weeks, or months. This helps in understanding the timeframe of the formation and, consequently, its importance.

2. Depth: The difference between the highest and lowest points within the pattern helps us understand the magnitude of price movement.

3. Volume: The number of shares traded during a specific period helps understand the sentiment of the buyers and the sellers. 

As described, the cup and handle stock chart pattern is a technical analysis pattern combining trend continuation and trend breakout patterns. This means the pattern can be seen emerging over time and used to your advantage if spotted correctly. The cup and handle chart pattern can be identified based on the above-mentioned key features:

1. The cup should be U-shaped and not a sharp V-shaped cup 

2. The base depth of the cup should be 12 – 35%

3. The handle should have a slight downward pattern and not an upward slope 

4. The slight downward pattern of the handle should not be more than 15%

5. The cup and the handle part of the pattern were formed over a minimum time of 7 weeks or 212.9 days

6. The handle has a minimum length of a week or seven days on the chart 

7. The pattern should form above the 200-day Moving Average (MA)

The above image represents a classic cup and handle pattern. Note that the cup is shaped in a U-shape and is not overly deep. The handle has a slight downward slope and remains in line with the top half of the cup pattern. The total formation of the pattern spans around seven months (from March to September). The base depth of the cup remains between 12 – 35%, whereas the slope of the handle remains below 15%. Finally, note how the volume (number of shares) decreases during the cup and increases during the breakout, indicating the buying and selling momentum. 

Now, that we understand the tactics for identifying the C&H pattern. Based on the critical features defined by expert analysts, any and all sorts of patterns can be identified, but to profit from these patterns, one should understand market psychology. 

Formation and Psychology

The formation of a pattern in the stock charts is due to investors’ and traders’ buying and selling behaviors. These patterns are thus not random and indicate the market psychology. This is also true in the case of the cup and handle continuation pattern. The best way to understand this psychology is in terms of accumulation, consolidation, and final breakout:

Accumulation:

A period during which buyers gradually enter the market and increase their positions. In the C&H pattern, the accumulation phase causes the cup to form as the stock experiences a pullback. The cup is generally seen as a positive sentiment in market psychology as investors anticipate gains shortly.

Consolidation:

A period where the stock price stabilises after the initial rise. In the C&H pattern, consolidation causes the handle to form. Here, the stock price might be traced back slightly, which may show the indecisiveness of buyers and sellers while showing that they are both active, which ultimately means less volatility in the market.

Final Breakout:

The point when the stock price rises above the resistance level. In the C&H pattern, a volume increase is seen when the stock finally makes a successful breakout, indicating a strong interest in buying. This new demand often leads to a surge in upward momentum, confirming the cup and handle pattern’s bullish nature.

The cup and handle pattern can thus be identified on the basis of its unique phases, which represent the psychology of traders and ultimately make or break a stock in the market. Conclusively, the link between market psychology and the formation of patterns plays a vital role in understanding stock price movements. Furthermore, anticipating how different emotions like greed or fear shape the behavior of a trader can offer valuable insights into the market’s potential trends, which can help increase the likelihood of successful risk aversion and profitable trades.

Trading the Pattern

Now that you know what the C&H pattern is, how you can identify it, and what its formation means according to market psychology, it is time to understand how the cup and handle pattern trading works and the cup and handle pattern success rate. Generally, there are three ways to trade any pattern seen in a stock chart.

These trading strategies include:

Entering/Exiting Trades

These trades involve determining the best points for entering or exiting a trade for maximum gains. The best point for entering is generally after a breakout above resistance, and the best point for exiting is based on price targets set in the pattern’s structure.

Regarding the C&H pattern, traders have key entering and exiting points. Ideally, a viable entering point is when the stock price breaks above the resistance level formed by the rim of the cup. An aggressive approach here would be to enter during the handle formation. 

Setting Stop-Losses

Setting stop-losses is a great way to manage risk. The stop-loss orders can potentially limit losses if the stock doesn’t behave as initially anticipated. The goal here is to minimise the risk while allowing the trade to develop comfortably. A conservative approach is to place the stop-loss just below the lowest point in the handle, as a stop-loss below this point might invalidate the pattern altogether. 

Confirm the Breakout

Before trading any pattern, it is most important to confirm the breakout. If you jump into a trade without confirming, you might end up at a loss. In the C&H pattern, a breakout is successfully confirmed when the price breaks above the resistance level with increased volume. The higher the volume, the more reliable the breakout shows strong buying intent. 

While the above strategies work great for cup and handle pattern trading and maximising gains, variations of these strategies can be used to trade any pattern. The key here is understanding market sentiment, calculating price targets, managing risk, and, most importantly, doing your own research before you accept someone’s views.

Real-World Examples

Examples from the trading world serve as the stepping stones to defining and understanding these patterns. Remember that the patterns are patterns because they have been seen forming in the real world in real-time over and over again. For this reason, it is crucial that we explain some of the most interesting and defining cup and handle pattern examples and stock case studies for your enhanced understanding. The examples are as follows:

1. Wynn Resorts (WYNN): The Wynn Resorts in Las Vegas showed an impressive C&H pattern in 2007. The pattern formed over a period of 5 years. The stock surged to over $164.48 from $11.5, indicating a solid and successful breakout. 

2. Microsoft Corporation (MSFT): In 2014, the tech giant printed two cup and handle patterns. The first pattern peaked at $41.66 in April, pulled back to the 38.6% retracement level, and successfully broke out in July, leading to a rally that approached a measured move target of $46. The second pattern features a V-shaped cup, but despite a breakout, the rally failed to reach the target of $50, calculated by adding the four-point depth of the cup to the resistant line near $46. 

3. Akami Technologies, Inc. (AKAM): In early 2015, Akami Technologies, Inc. consolidated $62 after retracing to major support at the 200-day exponential moving average (EMA) and formed a small rectangle pattern with support near $60.50. This rectangle held above the 38.6% retracement level, allowing for a bullish breakout that exceeded the measured moved target and achieved a 14-year high.

The cup and handle patterns are also seen in the forex markets. In intraday trading, the pattern tends to perform better during active times of a core currency pair, and subsequently, when the forex markets are closed, the pair tends to show less movement. All in all, there is insufficient momentum to display a successful breakout trend. The 2020 rift between the Euro and the United States Dollar shows an example of the cup and handle forex pattern. The EUR/USD pair displayed a cup and handle pattern formed over a few months. After forming the handle, the pair eventually broke above the 1.1900 resistance level, leading to a bullish rally. 

These real-world trading patterns are critical when trading a cup and handle pattern or any other pattern, for that matter. Remembering these patterns and their definitions are defined after various past occurrences is important. However, this does not mean that the related anticipation will be accurate every time the pattern forms. Therefore, it is always best to manage and mitigate your risk beforehand. 

Common Variations

The cup and handle pattern is formed by the buying and selling sentiments of the traders. This means that the pattern is ever volatile and thus comes with a few variations in structure formation. Here, we discuss the most commonly seen variations of the cup and handle pattern in stock charts:

Inverted Cup and Handle Pattern or Reverse Cup and Handle Pattern

The inverted or reverse cup and handle pattern primarily describes the same variation of the original pattern. These variations are a bearish variation of the classic cup and handle pattern. These inverted chat patterns resemble the C&H pattern, but the cup shape is an upside-down ‘u,’ showcasing technical reversal patterns. These types of variation mainly occur after a price increase, where the price gradually declines to form the cup’s trough, followed by a consolidation period that forms the handle. The handle slopes upwards and extends no longer than one-fifth to one-quarter of the reverse cup’s length. This bearish reversal or inversion variation indicates growing selling pressure after a period of upward movement, providing traders with a signal to capitalise on potential price declines.

Cup and Odd Handle Pattern

This original cup and handle pattern variation has a differently developed handle. The handle is shaped more angularly rather than the classic, smooth downward position, which is why it is called an Odd handle. Suppose we stay true to the pattern’s definition and the anatomy of the original handle. In that case, this odd handle still indicates a state of positiveness and might be a weaker signal for a bullish signal.

Multi-Year Cup and Handle Pattern

As the name suggests, the multi-year cup and handle pattern is a variation of the C&H pattern, which is extended over multiple years as opposed to the minimum period of 7 months of formation. In this version, initially, the cup represents a very long period of accumulation, followed by a recent period of consolidation. The multi-year cup and handle pattern still hints at the anticipated bullish result.

Intraday Cup and Handle Pattern

The intraday cup and handle pattern describes a complete C&H pattern condensed into a single trading session. This means that the pattern that would normally develop over a minimum period of 7 months develops within hours. The cup may form in the initial hours of the day, while the handle may form in the closing hours. The intraday cup and handle pattern maintains bullish, and aggressive traders see the opportunity to capitalise.

Here, we have mentioned the most commonly occurring variations of the original cup and handle pattern and their perceived market psychology. However, we would like to point out here that if the original pattern’s success rate is not foolproof, the success rate of these variations of patterns is even less foolproof. So, when trading with these patterns, always enforce strategies to mitigate your risk.

Tips for Success

For how to trade a cup and handle pattern, it is important to carefully understand its identifying tactics and patiently wait for the pattern to develop. This will not only help maximise your gains but also help manage risk. In the case of the cup and handle pattern, we have talked about seven points describing its formation in the chart, the trader’s sentiment behind the formation of such a pattern, and how to trade such patterns. All in all, the best tip we can offer for success in trading with patterns is to stick to your knowledge and always look for contributing evidence. Never stop learning and progressing your information bank when it comes to stocks.

Conversely, when trading remember the cup and handle pattern rules and make sure to avoid the following two most common pitfalls in order to maximise gains:

1. Inadequate Risk Management: The cup and handle pattern has existed for decades, and its careful identification has brought great profits; however, its success is not foolproof. Traders join the losing side when they do not implement adequate risk management strategies. 

2. Buying Before Confirmation: Premature buying or selling before true pattern recognition is still one of the biggest reasons behind loss in trading. Make sure that before you put in that trade, you have confirmed the pattern by all the means possible.

In the end, patience and understanding trading psychology are key here. Do not jump into a trade based on developing patterns. Wait and anticipate your next move. These are our tips for success, which will help you maximise your gains and minimise your losses.

Limitations of the Pattern

The C&H pattern is one of the most famous patterns in trade analytics. For decades, this pattern has brought immense gains and, consequently, losses to its traders. Like all analytic patterns, this pattern also comes with a number of limitations. Following are its limitations:

1. False Breakouts: Generally, a cup-and-handle pattern means a bullish trade has a strong and successful breakout. Sometimes, the pattern may give a false breakout, causing traders to jump at a false opportunity. This can be because of a number of reasons, but the biggest one is an immature pattern formation. As discussed above, patience is of the utmost importance here, and knowing when to enter and exit is crucial. 

2. Subjective Interpretation: This might be the biggest contributor to a cup and handle pattern failure. Most patterns and their formation are subject to interpretation. These skills come with time and patience and cannot be gained overnight. Secondly, because the interpretation of this pattern is subjective, the subject’s personal experiences, emotions, and biases also play a role in the interpretation. 

3. Time-Consuming: The pattern is largely time-consuming as it develops normally in around 7 months. That is a long wait for a lot of traders. 

4. Related Market Risk: No trade comes without some risk, and the cup-and-handle pattern is no different. We can see relative market risk as not a true limitation but as one of the qualities of this and all other patterns. Even though the cup-and-handle pattern success rate is known to be 95%, there is still a 5% risk involved. 

5. Requires Experience: A limitation of the C&H pattern that is universal to all trade patterns is experience. One cannot be successful in trading with patterns without gaining real-world experience. You can gain this experience by experimenting with technical analysis tools, pattern failure scenarios, and much more. The key here is to make yourself acquainted with the highs and the lows of trading. 

We have covered a lot of information about this trading analysis. We talked about stock continuation patterns, price projection and calculation needs, and technical pattern strategies, but what happens after the cup and handle pattern forms? We encourage you to use this pattern in conjunction with other chart patterns and indicators to maximise your gains and minimise your losses. Do not forget to implement your knowledge while making a decision and always give room for the pattern to develop comfortably. 

With experience, you will become accustomed to calculating the cup and handle pattern price targets for stocks and how to anticipate a pattern best. We hope this was an informational article and that you gained some valuable knowledge and insights about the C&H pattern.