Patterns are specific asset price movements within a certain time period. What they usually reflect is the behavior of the traders in response to some developments inside the market.
There’s no telling when a pattern will happen, but because each pattern firmly culminates in either a downward or upward trend, you might keep an eye out for the developing trends, such as Cup and Handle.
What is ‘Cup and Handle’?
The Cup and Handle pattern is one of the common indicators in trading. It’s called so because while the pattern is developing, the candles form these shapes from left to right:
- U-shaped recess (a Cup);
- Narrow and short, mostly bearish, stage (a Handle)
It usually results in a decisively bullish trend, and that’s why it’s so important to learn how to distinguish a Cup and Handle formation. If you know how it behaves and how to use it correctly, you can earn large profits in a relatively short span of time.
This shape can develop both in the short and long-term, ranging just from a few hours to a year. The timeframe mostly depends on the volume of the asset. When many people trade the same security at the same time, the trend is more reluctant to change and vice versa.
Why does the Cup form?
There are two main versions of a Cup and Handle pattern – one that reverses the downward trend and the other that confirms the ongoing upward movement. In both cases, as you can see, the end trend is still a positive one. It doesn’t mean, however, that C&H always continues into the growing price trend.
Remember: most patterns reflect the group behavior of many traders, and their collective response to price changes isn’t always identical.
Regardless, the pattern opens up when a long-ongoing positive/negative trend suddenly reverses either because the price hit the resistance/support or for some other reasons. The drop doesn’t continue for too long because, after a while, the fall is supposed to stabilize and form the bottom of our Cup.
Under ideal circumstances, the stabilization phase is necessary, although it shouldn’t go on for too long – the price is supposed to start climbing soon. But importantly, it also shouldn’t have a sharp V-shape where the bottom pretty much doesn’t exist. It signifies a sharp reversal.
While such cone-like cups do happen sometimes, they aren’t as reliable. The initial drop happens because traders decided to sell their assets en masse, while the stabilization stage signifies those traders are starting to check the trend and weigh their chances.
In the bottom area, the volume is usually much lower than before. Accordingly, the overall supply is able to rise and people eventually buy the stock en masse.
Why does the Handle form?
Once this price rise reaches more or less the place where the initial drop started, the growth ends and gets replaced by a timid bearish shift – the Handle part.
The handle is much shorter and narrower. The price range doesn’t fall beneath the upper half of the cup’s own depth (at least under normal circumstances). So, if the top of the Cup is at around $1,000, and the bottom is at $900, then the Handle is supposed to range between $1,000 and $950.
Ideally, it’s supposed to be in the upper third – between $1000 and $966. If it’s not, then it’s not the true Cup, and trusting it could be risky.
Anyway, the Handle isn’t supposed to last for too long – not longer than the Cup’s own length, at least. It usually ends in the same place it started – at the top of the Cup, more or less. After this point, the trend is supposed to rise for some time.
How to use Cup and Handle
Unless the Cup and Handle pattern has some definite structural flaws, it’s supposed to develop into a rising trend, regardless of the trend before the C&H started. If the pattern’s developing correctly, you’re advised to follow this tactic:
- Place a stop-loss at the top of the Cup for risk management;
- Wait until the Handle reaches its end – just above the same level as your stop-loss;
- Invest into the stock. If the pattern is correct after all, you’ll earn profits – if not, you’ll still have stop-loss.
The length of the following bullish trend is hard to estimate. For this reason and because the pattern may not always be truthful, you’re also advised to use other indicators and tools. They’ll measure whether C&H is developing right. The trend length is hard to measure, although there are several ways to verify the pattern.
First of all, it’ll be prudent to know where the current support and resistance zones are, as well as what current demand and supply look like. Fibonacci indicators and pivot points will help you with that.
Secondly, you’ll have to keep an eye out for the volume. The true Cup doesn’t usually have a very high trade volume at its bottom. If it’s not particularly smaller compared to what it was before the pattern, then you might want to be skeptical.
Lastly, you might want to learn other common patterns to see if the initial stages of the Cup could actually be some other, less complex pattern.
Final Thoughts
Although Cup and Handle chart is supposed to be trustworthy, you shouldn’t rely solely on its help. Chances are you’ll be seeing it a lot in different timeframe sizes. Since it’s easy to get confused around this pattern, you’ll require more help from other tools described above.
