There are different methodologies investors use for stock analysis. Technical analysis studies stock movement over a period of time and patterns emerging from them. Different shapes emerge as patterns that indicate a trend in price movements. One of these is the cup and handle pattern.
A cup and handle pattern is formed when the charts indicate the forming of a U-shaped cup followed by a handle with a sloping shape. It is one of the most common shapes witnessed in price movements that a trader can use to his advantage. The cup and handle pattern indicates a bullish continuation movement. It gives the investor a clue that the upward trend is likely to continue.
When this pattern begins to form, it signals that the upward movement is likely to appear and continue. The trader can use the bullish trend indicated by this chart in trading and make informed decisions. It was popularized by American technician William J. O'Neil, who discovered this pattern in his book “How to make money in stocks” in 1984. It is a classic chart analysis used the world over to study stock patterns and benefit from trends.
How Did the Cup and Handle Pattern Form?
The cup and handle formation appears when there has been an upward movement pattern. This is a bullish upward continued pattern.
The trend is confirmed as cup and handle formation only when the stock price surpasses the resistance level and shows an upward movement. Only then can a trader get a confirmation that the higher price stock movement is going to sustain.
When a stock begins to move upwards and shows a bullish pattern, traders continue to invest in the stock’s growth and positive trend. As the stock breaches high levels, investors who came in at the beginning of the uptrend start booking profits. At this level, the upward trend halts, and the price falls with selling pressure. At this stage, the cup formation curves downwards in a bowl shape. As traders and investors continue to book profits, the cup moves lower, indicating a temporary downward cup.
At these levels, savvy investors, traders, and institutions begin to pump funds into the stock at attractive levels due to the fundamentals of the stock or value buying. At these low price levels, buying comes in, and with buying pressure, the cup curvature starts moving up to reach the resistance line. At this stage, an entire curved bowl shaped cup is seen.
The handle emerging here is interesting to note and indicates human psychology. The trader who had invested at the peak of the resistance line before the stock dipped is eager to take his capital back as the stock moves up. Moment stock touches the resistance level, and this trader sells. Also, the traders who started buying at the bottom of the cup look at the resistance point as a safety level to book profits. There is selling pressure at resistance levels, and the upward cup shape is halted.
The volume of stocks also identifies the cup and handle at the beginning of formation at the end of the cup curve. The volume of shares is low at the end of cup formation as the selling is not heavy here. The investors who bought at the previous resistance level their capital and sell. Short-term traders without a fundamental view sell at the seeming peak of the stock.
The institutions and experienced investors hold on to the stock bout at cup bottom. The selling volumes are low and don’t push the stock price down. The buying also continues, and if large volumes of buying hold, the stock breaks the resistance level, and upward trends emerge, making a handle pattern.
How to Trade Using a Cup and Handle Pattern?
As a trader, it is important to identify and understand some key points:
Cup:The cup should emerge as a U shape, not a sharp V pattern. A rounded U shape shows a gradual uptrend from the bottom levels.
Handle:The handle emerges as a breakout from the edge of the cup, moves downwards, and then breaks into a price breaking the resistance. Its stock price in handle goes below the resistance and cup levels. Handle forms over a few days and not a sharp plunge.
Volume:The upward movement from the handle should show high volumes, then only it is deemed a continued bullish trend.
Past Trend:The cup and handle pattern should show up after a continued upward trend for a few months, not a break jerk. If the pattern emerges after a prolonged upward trend, it may be a weak pattern without much upward potential after this.
The cup depth is usually up to 1/3rd of the edge prices, but it can go even ½ deep from the edge price in extremely volatile conditions.
The cup forms in a time frame of one to six months or one year usually and is not an overnight trend or pattern; similarly, the handle forms over a week to two. A gradual formation shows a sustained trend.
A trader can spot a breakout with a precise volume increase after the cup and handle emerges. This is a good opportunity to enter the stock. Traders can also track the resistance line; as the stock touches the resistance price after the breakout, it is a good long buy to enter. Traders can keep the handle bottom to stop loss and gain from the upswings. Experienced traders with a higher risk appetite place stop loss at the bottom of the cup as well for higher gains.
A cup and handle pattern is an easy and highly popular pattern used by traders in the market. Experienced traders easily spot the pattern to take advantage though a new trader may need more observation of past trends to spot this pattern. It is observed not only in shares but also in forex currency markets as well. It is easy to spot compared to other technical charts because it shows clear entry and exit points for a trader. Since the pattern emerges over a long period without sharp movements, it is relatively easy for new traders to observe and take positions.
The possibility of successful trend spotting is higher in the cup and handle pattern as long as the trader applies to stop loss at the right price point and time. Combined with fundamental analysis, technical charts can be a great tool for new and experienced traders both. If you want to invest in markets with technical and fundamental knowledge, open a demat account with us, and we will help you succeed.