A Comprehensive Guide on the Cup and Handle Pattern Trading

Learning about a cup and handle pattern is important for traders and investors who want to make informed decisions when trading in the financial markets. In technical analysis, the cup and handle is one of the reliable indicators of a continuation of a bullish trend. By understanding it, traders can confirm the trend of an asset and identify potential buying opportunities.

Additionally, by knowing how to trade this setup, traders may minimise their risks and protect their capital. Therefore, in this FXOpen guide, we will look at how it works, how to determine it, and how we can trade with it.

What Is a Cup and Handle Pattern?

The formation was recognised by William J. O'Neil in his 1988 book, "How to Make Money in Stocks." He added technical requirements and a detailed description of its unique teacup appearance through a series of articles published in the “Investor's Business Daily” newspaper.

This formation indicates the reversal of a bearish trend. It suggests that the asset has consolidated after a fall and is now ready to move upward. Traders can use it to identify potential bottoms and new trend shifts. However, they should be aware that not all signals are reliable, and other technical indicators should be used to confirm the setup's validity.

Is the cup and handle a stock pattern? It can be found in stocks as well as forex, cryptocurrencies*, indices, ETFs, and commodities. It is a bullish continuation setup that signals that a price is likely to move in an upward trend after a brief consolidation period.

It typically forms when the price of an asset drops, then rises again to its previous level, making a rounded bottom. This rounded bottom is known as the cup, which is followed by a short-term drop known as the handle. Is the cup and handle bullish or bearish? The cup and handle is a bullish setup, but there is an inverted cup and handle formation that signals a bearish trend continuation.

Cup and Handle

Inverted Cup and Handle

How to Read the Cup and Handle Pattern

Finding the cup and handle in forex is relatively common, but it can mostly be found in stocks. So what does the cup and handle mean in stocks?

The story behind the formation is that, after a continuous downtrend, the asset price makes its first rise. This initial rise is followed by disbelief in the uptrend and the first encountered selling pressure, resulting in a handle formation.

The cup part is the accumulation zone, with the asset experiencing a period of low trading activity, which can be verified by the low trading volumes. After this period ends, a newly found interest is seen following the sentiment. A shift that is hard to occur usually results in selling pressure on the previous levels. This is how the handle is formed.

Traders consider the cup and handle pattern rules when detecting it on a price chart. The length of the cup is important: the cup should look more "U'' than "V" so the signal is more reliable. The depth should not be excessive, and the handle should form in the top half of the cup. Additionally, the volume should decrease as the price declines and remains lower than average in the base of the bowl. When the asset starts rising to test the previous high, the volume should increase.

As for the handle, the wider it is so that the top is far away from the highs, the more significant the breakout is expected to be. By considering these factors, traders can use the cup and handle chart pattern to set buying and selling points.

How to Trade the Cup and Handle

To trade the pattern, traders wait for the handle to form and for the price to break above its upper boundary. To identify the handle’s upper boundary, you can draw trendlines through its highs and lows. This breakout should be accompanied by a high trading volume, indicating that there is strong buying interest.

To validate the formation, traders look for other technical indicators, such as a simple moving average or trendlines, that suggest there is an uptrend. Once these indicators confirm the trend, traders can enter a long position with a stop-loss order below the handle's support level. When it comes to projecting a take-profit level, generally, this should be done by measuring the length between the lowest point of the rounded shape to the horizontal resistance and placing it on the breakout level.

Trading Example

Let's look at an example of the cup and handle trading pattern on our trading platform TickTrader. The cup and handle in the graph below started forming at the beginning of December 2022.

A retest of the previous highs occurred, with the price proceeding to form the handle. After the handle was formed, a breakout took place.

This is where an entry could be placed as the safest way to validate whether the expected formation will play out. The horizontal resistance breakout indicates that the formation is complete and that we might see further uptrend continuation.

A stop loss can be placed on the horizontal resistance zone or slightly above it, which depends on the projected target levels. The take-profit target would equal the distance between the bottom of the cup and the horizontal resistance, and it would be placed at the breakout level.

Final Thoughts

The cup and handle setup is a useful technical analysis tool for traders looking to identify potential buying opportunities in the financial markets. We have discussed what this formation is, what it represents, and how to use it in trading. So if you feel ready to start trading this formation, you can open an account and use it to your advantage.

*At FXOpen UK and FXOpen AU, Cryptocurrency CFDs are only available for trading by those clients categorised as Professional clients under FCA Rules and Professional clients under ASIC Rules, respectively. They are not available for trading by Retail clients.

Text source: Forex Trading Blog

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