swing trading

Cup and Handle Chart Pattern - How It Works and How Traders Can Use It

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When it comes to the stock market, sometimes you might hear the term "cup and handle" mentioned. It refers to a stock chart pattern that is popular among active stock traders.

This article will explain what a cup and handle chart pattern is and how traders might be able to benefit from using it.

 

What Exactly Is a Cup and Handle?

Imagine looking at a stock chart and seeing a pattern that looks like a tea cup with a rounded bottom and a spout-like handle. In trading terms, it looks like this:

Cup Part: The left side of the pattern has a decline in price, then reaches a low point (like the bottom of the cup), and then begins to rise back up roughly the same amount as it declined.

Handle Part: After the cup is formed, a cup and handle pattern is completed when there is a much smaller price decline followed by another price increase.

There are therefore at least two troughs on a cup and handle pattern: the big one from the cup and the small one from the handle.

The high points of both the cup and handle would typically form a relatively straight horizontal line. This might be thought of as a resistance level.

 

 

That image is a graphical icon that gives an idea visually of what a cup and handle chart pattern looks like.

 

What Does a Cup and Handle Look Like On A Stock Chart?

The image below is an example of a cup and handle pattern as shown on one of our stock charts.

 

 

There are golden lines on our charts that automatically outline chart patterns when they're detected.

You can see how the price bars make up a pattern that looks like a teacup and handle. The golden lines aren't rounded, but they help convey the idea that there is one big trough and one small trough, with a flat level resistance across the top.

 

How Do Traders Use a Cup and Handle?

The logic behind this pattern is that the lowest trough (the cup) marks a support level that might protect against a further decline in price. The existence of the handle (a higher trough) reinforces this notion.

Many traders therefore consider a cup and handle pattern as a signal to buy. The idea is since new higher support levels are taking shape, it's a sign of strength and the price might not be likely to go below those levels moving forward.

A trader might wait for the price to rebound past the price peak level along the top of the cup and handle before buying the stock. That would be like a breakout trade. The idea here is that the trader is waiting for confirmation that the price rebound will surpass the potential resistance level of the two price peaks.

Alternatively, a trader might consider buying the stock after the stock has formed the handle of the pattern in anticipation of an ongoing price rebound.

 

Is a Cup and Handle Bullish or Bearish?

Cup and Handle patterns are generally considered bullish chart patterns, meaning that the presence of a cup and handle on a stock chart might be an indication that the stock price is on the verge of going up.

Since a cup and handle is typically considered bullish, it means traders might try to capitalize by going long (meaning that they would be buying instead of shorting).

 

How Do You Find Stocks That Have Cup and Handle Patterns?

You can find them by using our Cup and Handle scanner. It's a free tool we offer here at Stock Market Guides. It uses our proprietary scanning technology to find stocks that are in a cup and handle chart pattern.

Here's how the scanner results look:

 

That tool ensures that you don't have to waste time flipping through stock charts manually to find stocks with a cup and handle pattern.

 

Example of a Cup and Handle Trading Strategy

For this example of a cup and handle trading strategy, we're going to use a daily chart, where each price bar represents one day of price activity. That means it would be a swing trading strategy where the trade is designed to last more than one day but not for the long haul.

For our sample trading strategy, the cup and handle rules are as follows:

 

Entry for the Cup and Handle Trading Strategy

The entry for this Cup and Handle trading strategy will be as follows:

The entry criterion for our Cup and Handle trading strategy is very simple. You can see in the stock chart below for Pinnacle West that the entry price would be right around $95.

 

 

Exit for the Cup and Handle Trading Strategy

There are a lot of possibilities here for the exit.

One benefit of using a stock chart pattern as a basis for making trades is that the pattern itself can help you determine exits in some cases.

For any given trading strategy, it can be helpful to define three different criteria for the exit: profit target, stop loss, and time limit.

Not everyone uses all three, and that's totally fine. Ultimately, you can set these values however you want. But for the purposes of this strategy example, we will define all three:

 

1. Profit Target

We will set the profit target at 2 ATRs away from the entry price.

ATR is an indicator in the stock market that measures a stock's recent price volatility. Most trading platforms have it available as an indicator you can enable.

Our profit target criterion indicates that we will take the ATR value of the stock, multiply it by 2, and add it to the price we paid when we bought the stock. That will be our profit target and we can set up a sell limit order at that price.

2. Stop Loss

We will set the stop loss at 2 ATRs below the support line of the handle (the lowest price of the troughs of the handle). This means we take the ATR value of the stock, multiply it by 2, and subtract it from the handle's lowest price.

That will be our stop loss and we can set up a stop order at that price.

3. Time Limit

We will set the time limit as one week since this is a swing trade. If the stock has not hit either the profit target or stop loss by the time limit, then we will close the trade manually at the opening bell seven calendar days after entry.

 

How Well Do Cup and Handle Patterns Actually Work?

The idea of a cup and handle trading strategy sounds nice to many people because it offers a clear, easy-to-understand way to find and manage a trade setup.

But does it actually work? Can traders indeed generate profits by trading cup and handle chart patterns?

That's exactly what our company can help answer for you, since our scanner technology has allowed us to do our own research on that precise question.

The answer is that trades based on a cup and handle are not always profitable, but for certain stocks they might indeed have a track record of success according to our backtest research.

Here is some data that shows how a proprietary cup and handle trading strategy we created has performed historically according to backtests:

 

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Anyone who signs up for our swing trading scanner service will be able to see stocks that qualify for that trading strategy in real time.

 

Learning More About Cup and Handle Patterns

You can contact us any time if you would like to ask any questions about cup and handle patterns or anything else related to the stock market.