Cup and Handle Pattern

Article Summary:

A cup and handle pattern is a trading pattern consisting of a rounded bottom and a downward drift that looks the handle of a cup. The cup and handle pattern is generally considered a bullish continuation pattern that indicates a further move to the upside.

“Continuation or reversal?” This is a phrase often uttered by traders as they watch the financial markets progress and spot patterns. Trading chart patterns, of course, need to be combined with a variety of different technical analyses before a trade takes place. That being said, if a trader understands how to spot a pattern and the psychology or sentiment behind the pattern, they can select a spot to get in that might offer more value than most. Traders with a bullish trading thesis will look for a time to get into the market when the price is at an attractive level and before the asset continues its ascent. Many traders will look for a cup and handle pattern before placing a trade, betting on a continuation of a bull run.

What is a candlestick pattern?

A candlestick pattern is a graphic representation of changes in price on a candlestick chart that some traders believe can predict future price movements. Bullish patterns predict increases in price, while bearish patterns indicate that the price may drop. Check out our in-depth article about how to read these charts and some other common patterns.

What is a cup and handle pattern?

The cup and handle chart pattern is a continuation pattern and one of several technical indications that there will be a continuation of a bull run and an upward trend in the asset price. Cup and handle patterns are made up of a rounded bottom shape, similar to a U. This is similar to what you would find in a rounded bottom pattern or cup pattern. The cup forms with a descent that rounds in when the sellers begin to lose momentum. It will then hit a low point that represents the bottom of the cup. Once the low point is reached, the pattern will round up, with the buyers gaining momentum. At one point towards the top of the right side of the U shape, a further narrowing and consolidation of the price will occur many times in a downward trajectory. Once the price action breaks out of the handle shape, the price rises, and it should continue its ascent.

cup and handle patternThe cup and handle pattern represents a period of time when buyers who have an overall bullish thesis can get in. The pattern represents several momentum shifts from buyers to sellers and vice versa. However, at the end of the pattern, the buyers will come out with the power and momentum and push the price up. The cup bottom will form a U-shape like a rounded bottom rather than a V. This is important to notice because a V-shape could indicate a random spike in price action and thus not qualify as a true chart pattern.

What makes up a cup and handle pattern

A cup and handle pattern will consist of the following elements.

Consolidation

Consolidation occurs when the market is trading within a range. It’s generally attributed to market indecisiveness, in which there are no clearly defined breakout trends yet.

Peak reached by an uptrend

The cup and handle pattern will generally be preceded by a bull market. The bull market then reaches a small peak before it makes its descent.

Rounded downward descent

After reaching the peak, the pattern will begin to form by gradually declining and leveling off. As the shape descends, the sellers are losing the ability to exact pressure and then losing momentum until it reaches a middle point.

Low point (bottom)

Just like a U has a point that you can put smack dab in the center, so does a bottom in a rounding bottom chart. This is the point that the price action descends to before beginning to turn upward.

Upward trend gathering momentum

After the asset price hits bottom in the U-shape, it begins to start trending upwards. It starts to gain momentum as the price ascends. Finally, it hits another peak.

A second peak then narrow trading range downward

When the asset price hits the peak of the U (remember the pattern started from a peak), it will then go through a period of price narrowing, many times trending downward. This makes up the handle formation. The trading range will narrow, and the handle will continue until the asset price breaks out.

Breakout to the upside

The cup and handle pattern target is a breakout to the upside. At the breakout point, the buyers now have all the power. The asset price should now break to the upside and continue its upward trajectory.

Real-life example: Mastercard

cup and handle pattern
Source: Trading SIM

The chart above is an example of a cup and handle forming with Mastercard stock in 2016. The pattern begins to form in the middle of June. The sellers push the price down until the beginning of July when the price bottoms out. The price begins to ascend gradually as the buyers gain momentum.

At the beginning of August, the handle starts to take shape. The sellers are most likely taking profits at this level, and the price begins to decline and narrow significantly for two weeks. After a couple of weeks, the price breaks out and resumes its upward trajectory as a continuation of the prior bull run.

Sure, everyone loves a break to the upside. However, with upsides come downsides, and having a retirement plan set up while you are trading can hedge against trading incorrect patterns. Here are some advisors that can let you sleep soundly, knowing your retirement is covered, regardless of your success in trading.

What happens during the formation of the U?

A cup and handle pattern would have been preceded by a bull market. At some point in a bull market, there will be a time when buyers will close their positions and take profits. At the same time, sellers will begin to put pressure on the asset price, pushing it down. This is what happens at the first peak of the U. The buyers are taking profits, and the sellers are pushing down. The sellers will push down hard at first but then begin to lose momentum. This is where you get the leveling off of the U before it hits bottom.

Once the U hits bottom, there should be a gradual ascension up, slowly gaining momentum. This represents the buyers pushing the price up and getting in at ever higher prices. The buyers push the price up until it hits the second peak and then forms the handle.

Why does the handle form?

The handle of a cup and handle pattern forms because the buyers have pushed the price high enough for the sellers to start closing their positions. As the sellers close their positions, the price of the asset will start being pushed down on a relatively short downtrend. The asset price has become too high, and the sellers also think that they need to exit. Otherwise, they will get walloped with a bull run. At this point, both the sellers and the buyers think the asset price will go on an upward trajectory. The sellers close positions to manage their downsides. Once it reaches a point when the price is just too good, the buyers will pile on and push the price up.

Pro Tip

It’s important to let the cup and handle form properly before verifying it as a pattern. Many traders will try to avoid a cup that is close to a V rather than a U. Furthermore, the handle needs to be formed properly, with a narrowing of trading. This will help reduce the risk of false breakouts.

Volume and time frame

When the U-shape forms, the trading volume should be similar to that of a rounded bottom and mirror the shape of the U. The volume levels off until it hits the low point at the bottom of the U and then begins to pick back up again. The volume should increase until it hits the U’s second peak and then decrease as the trading range narrows. Once the asset price hits the breakout point, the volume should then increase significantly as buyers jump in to push the price up. The pattern generally forms in a duration of weeks, although it can be shorter or longer.

Cup and handle trading philosophy

Let’s review how traders would respond to a cup and handle pattern.

How to open a trade

Aggressive and conservative traders, once they have defined and verified the pattern, will enter at different levels. A more aggressive trader might enter the trade at any point inside the handle. If they are very aggressive, they might put the entry point somewhere around the resistance line of the handle, which makes up the upper trend line. This would indicate that they are sure of the pattern and that it is poised for a breakout of the handle. A more conservative trader might wait to open a trade on a candlestick after the price has broken out of the handle. This could include a pullback and a retest before they are certain the price has broken out and they execute a buy order.

How to manage the downside

As with most trades, using a brokerage and managing the downside is defined by your risk tolerance and your price target. A more conservative trader might put a stop loss exactly at the support line of the handle, maybe even slightly above it. A more aggressive trader, who is ok with a little volatility and intense swings, might put a stop loss well below the handle but within reason. This would indicate that their other technical analysis reveals that the asset is undervalued at market price. Therefore, it’s most definitely going to continue a bull run in the near future.

Managing the downside when you open a trade is an important part of trading. As traders progress, they become much better at it. The only way to progress is to practice, and these brokerages can get you started.

FAQ

Is a cup and handle pattern bullish?

Yes, the cup and handle pattern is generally considered a bullish continuation pattern.

How reliable is a cup and handle pattern?

The cup and handle pattern is considered one of the more reliable patterns, as long as it is verified correctly. The narrowing trading range where the price moves up and down on the handle is one of the main spots to verify the pattern.

Can a cup and handle form on a downtrend?

For it truly to be a reliable cup and handle pattern, the pattern must form on the back of an uptrend. An inverted cup and handle pattern might form during a downtrend. The inverted cup and handle indicate the continuation of a preceding bear market or downtrend.

Can the cup and handle be bearish?

The cup and handle pattern can be bearish if it’s an inverted cup and handle pattern that forms with a downtrend preceding it.

What happens after a cup and handle pattern?

After a cup and handle pattern, there should be a break to the upside. On an inverted cup and handle pattern, there will be a break to the downside.

How do you scan for a cup and handle pattern?

Charts can be difficult to read and verify. However, as a general rule of thumb, the pattern is verified once the creation of the handle is complete. However, many traders will tell you that the handle’s support line shouldn’t exceed the middle of the point of depth of the U-shape.

Key takeaways

  • A cup and handle pattern is a technical chart pattern consisting of a rounded bottom and a trading range afterward that imitates the handle of a cup.
  • The pattern is considered a continuation pattern that occurs after a bull run precedes it.
  • The handle formation is dictated by a decline in volume and the trading consolidating in a range, in many cases on a slightly downward slope.
  • A cup-and-handle pattern offers traders a point to get in if their other technical analysis stipulates that this asset should continue to ascend.
View Article Sources
  1. How to Day Trade the Cup and Handle Pattern – Trading SIM
  2. Anatomy of a Cup-with-Handle Chart Pattern – Breakout Watch
  3. Trading with the Cup and Handle Pattern – Daily FX
  4. How to Read Candlestick Charts – SuperMoney