One of the most common chart patterns is the cup and handle pattern. Learn more about the cup and handle pattern, how to identify it on a stock chart, and how you can use it in your trading.
The cup and handle pattern is a pattern found on stock charts that resembles a, you guessed it, cup with a small handle. The pattern gets its name from the visual image it makes on the chart. The cup is a curved u-shape or rounded bottom, while the handle slopes slightly downwards.
A few key factors contribute to forming a cup and handle pattern. Investor sentiment is important– cup and handle patterns typically appear when investors feel bullish but are starting to get a bit cautious.
Another factor is price resistance, when a stock reaches a certain level and retraces as sellers overwhelm buyers. The cup part of the pattern forms when the stock price starts to rise again after hitting a resistance level. The handle part forms when the stock price falls back to a level just below the cup.
The cup and handle is a bullish stock chart pattern. The measured move for a cup with handle is the distance from the right-hand top of the cup to the bottom of the cup.
How to trade the cup and handle stock chart pattern
There are a few things you need to know if you're thinking about trading this pattern. It's important to wait for the cup and handle pattern to form completely before entering a position. Once the cup and handle pattern has fully formed, you can look for a breakout above the cup.
A breakout happens when the stock’s price moves above the resistance level formed by the top of the cup portion of the pattern. This is the classic entry trigger for a trade. To protect against losses, many investors set a stop-loss order at a level below the cup and handle pattern.
Are cup and handle patterns reliable?
While cup and handle patterns are generally considered one of the more reliable trading signals, it's important to note that no chart pattern works all the time.
Failed breakouts occur when the stock price fails to break out and remain above the resistance level. This can happen because of waning investor sentiment or insufficient buying pressure.
There are a few additional indicators traders combine with this pattern that suggests continuation or a strong buy signal:
- Generally, cups shaped like a “u” are more reliable than cups shaped like a “v.”
- The handle should not be too deep. Look for cups with a bottom roughly in line with the price area where the cup began to form. A deep handle would cause the pattern to resemble more of a “w” than a cup and handle.
- Volume should be lower as the price declines, then expand as the price moves higher.
Inverse cup and handle pattern
An inverse cup and handle is a bearish reversal pattern that typically forms after a prolonged uptrend. As its name suggests, the inverse cup and handle is the opposite of a bullish cup and handle.
The cup is formed as the price consolidates in a small range following a sharp decline. This consolidation forms the "handle," which is typically a shorter-term downtrend. Investors typically trade an inverse cup and handle by selling when the price breaks below the handle. This break signals a continuation of the downtrend.