Cup and handle patterns are valuable components of comprehensive trading strategy guides. But what are they, and how can you ensure they don’t wind up irreversible blunders?
This article discusses what cup and handle patterns are and how you can use them to benefit your investment strategy. It also discusses some of the formulas and software to help you with your cup and handle strategy.
The most critical factors of cup and handle patterns deal with entering and exiting them at the right time (as with other trades). However, you can use specific indicators to determine the ideal entering and exit points for your cup and handle patterns.
Cup and Handle Pattern
Cup with handle patterns can occur in both short and long-term time frames. Cup and handles happen when there is a price wave down, followed by a stabilizing period, and followed by a rally of relatively equal proportion to the previous decline. This market behavior forms a U-shape pattern and then a stabilized period- hence, the name “cup and handle.”
The market can experience a short burst, forming a triangle portion in place of the typical handle. However, for an authentic cup and handle pattern, the handle needs to be smaller than the cup. The handle should hold steady before reaching the lower half of the cup. If cups form between, If the handle is too steep, it erases most of the gains of the cup.
Cup and handle patterns may signal either reversal patterns or a continuation pattern. Reversal patterns occur when the price is in a long-term downtrend. The subsequent pattern reverses the trend, and the price starts rising. Continuation patterns occur during uptrend. The price rises, form a cup and handle, and then continue growing.
Cup with Handle Price Screeners
There are a few automatic screeners that search for cup and handle patterns. Most of these locate cup and handle patterns on daily charts. These patterns form during the previous weeks or months.
You can find one of the formulas used for identifying cup and handle patterns using Amibroker, a stock chart analysis, and market screening software. Amibroker’s library uses a formula that describes scanners for cup and handle patterns.
The other option is FinViz website and its stock screeners options. FinViz doesn’t have the same cup and handle screener on its site, but you can use similar chart patterns to locate opportunities. This tool identifies stocks with the appropriate triangle patterns that classify cup and handle patterns.
FinViz is preferable for traders who aren’t trying to spend money on software. However, Amibroker has more in-depth analysis tools.
Entering a Cup and Handle Pattern
The entering point for a cup and handle pattern is the descending channel or triangle. When the price peaks above the top of the channel or triangle, you should buy. When the price exits the handle, the pattern has run its course, and the price will rise if it behaves as expected.
The price won’t necessarily rise- it could increase slightly and then fall hence why traders should implement a stop loss on their position.
Setting a Stop Loss for Your Cup with Handle Pattern
Stop-loss orders help traders exit their position before it becomes too financially damaging. It works by setting a specific price, at which your broker does not let your position fall any further. For example, if you enter a stock at $20.00 and set a $17.00 stop loss, you would automatically sell the stock if it dipped to or beneath $17.00.
When it comes to cup and handle patterns, place the stop loss at the lowest point of the handle. If the price undulates up and down within the handle, you could consider placing the stop-loss beneath the most recent swing low.
You shouldn’t place stop-losses within the upper half of the cup. Properly placed stop-losses shouldn’t end up within the lower half of the cup formation. Keeping the handle and the stop-loss in the upper-third of the cup supports the stop-loss near the entry point, improving the trade’s risk-reward ratio.
Picking a Target or Profitable Exit
When deciphering an advisable exit point for your cup with handle trade, add the height of the cup to the breakout point of the handle. The resulting point should be your target exit point.
Sometimes, the left side of the cup is a different height than the right. In this case, use the smaller height, and add it to the breakout point for a consecutive target. You can use the larger height for an aggressive target.
You can also use a Fibonacci extension to pick a good exit point. You can also use the extension tool from the cup low to the high on the cup’s right and then connect it down to the handle low.
As a day trader, if you don’t reach the target by the end of the day, you should close the position before the market closes. You can also use a trailing stop-loss to get out of a position to move close to the target.
Cup and Handle Time Frames
You typically see cup and handle patterns on daily charts after a strong trend of one or more months. The longer trends progress, the less likely a cup and handle pattern is to form. Additionally, if a cup and handle pattern forms, it is expected to produce smaller continuation movements with less upward potential.
Cup and handle patterns can occur on intraday time frames. However, these trading patterns require quick recognition and breakout confirmation at the end of the handle for profits.
Cup with Handle Patterns Simplified
Don’t let the jargon confuse you. Cup with handle patterns simply form in response to consolidation after up-trending stocks test their previous highs. Traders who bought the stock near previous highs will sell at this point. This action causes a gentle pullback, which, in turn, gets met with bullish activity. The bullish movement causes the rounded bottom and rise of the right end of the cup.
After the stock once again tests the highs, it experiences another pullback, causing the handle. After the stock steadies, investors can then push the stock higher at discounted shares.
Cup and Handle patterns are excellent tools for day traders to keep in their repertoire. If you’re considering using a cup with handle pattern strategy, you should use a stop-loss to protect yourself from getting too hard; cup and handle patterns don’t always behave as expected.
The prime location to enter a cup with handle position is at the bottom of the descending triangle. Entering at this point ensures that you avoid the stock when it’s at its most volatile state. The prime location to exit the position is debatable and requires some arithmetic. You can either use a Fibonacci indicator or add the smaller height of the cup to your breakout point.
Timing is everything with cup and handle patterns as it is with most trading strategies. If you can’t enter and exit at the correct times, cup with handle patterns lose their potency and wind up costing you more harm than good.