The cup and handle pattern is one of the more bullish technical signals that traders commonly look for. As the name suggests, the pattern resembles a cup and a handle; it’s comprised of a U-shaped cup followed by a handle that is denoted by a modestly downwardly sloping trendline.
Traders looking for technical signals view the cup and handle as a bullish continuation pattern. Understanding the cup and handle could therefore help you hit that buy button with greater success.
Early in the cup pattern the asset is testing a prior resistance level and so attracts some selling pressure. At this point, investors are typically selling the asset to lock in trading profits from the recent spike in the price.
Others may be selling to break even as they may have bought the asset at this higher level previously.
The price consolidates, heading towards the bottom point of the U curve due to selling pressure. However, this proves a temporary phenomenon as buyers enter the market to take advantage of the lower prices. In fact, the buyers soon win the tug of war with the sellers and the price moves back up again, forming the upward phase of the U curve.
Trading volumes should decline at the bottom of the cup and rise again when the price is on the up in this second phase.
In the subsequent handle period, there is more profit taking once again. Traders tend to view a breakout from this handle phase as a buy signal. Crucially, the handle phase is characterised by lower trading volumes, while the breakout itself should be denoted by higher trading volumes to represent a valid buying signal.
The further the distance that the top of the handle is away from the prior highs, the greater the breakout must be.
A typical trading strategy using the cup and handle is to place a buy order just above the trendline of the handle phase. However, we could also wait for the asset price to close above the trendline.
This might be a safer option, because then we could give ourselves more time to analyse trading volumes and other sources of information, providing us with the conviction that this is a true breakout.
If it is a true breakout from the handle pattern, then we should expect a fairly sharp move upwards in price once the top end of the handle trendline has been breached.
As always, it’s important to have a stop-loss order in place in case the price does retrace. For instance, we could implement a stop-loss order just below the handle trendline.
As an example, suppose we are trading gold and the price had reached $1,342 per ounce in the early part of the U curve before retracing to $1,335 at the bottom of the cup. We then observe the price reach $1,341 before entering the handle phase. We see the price at around $1,338 in the handle phase, with a slight downward trend on low trading volumes.
One day, the price suddenly closes above the trendline of the handle phase, at $1,339 amid higher trading volumes. We implement a buy order at just above $1,339 on the following day, while also putting on a stop loss at $1,337.
Happily, the price behaves much as we expected, and we see further strong movement. We close out the position at the end of the same trading day with gold trading at $1,343. We are pleased with our trade, but as it happens had we held on for another day we’d have an even better result.
Gold closes the following day at $1,344 and even makes further upward progress over the following days and weeks.
A typical strategy is to set the profit target for the buy trade using the distance from the bottom of the cup to the handle breakout level.