How to Trade the Cup and Handle Pattern?

Cup And Handle Pattern

The Cup and Handle pattern is one of the highly profitable chart patterns. This comes after a prolonged downtrend in some stocks in the stock market. After this downtrend is over if the stock shows this chart pattern typically we can see a formidable rally in the stock afterward.

What is the Cup and Handle pattern?

Typically in this pattern, a stock shows a steady uptrend for up to 2 to 4 months. Then it undergoes a market correction. The stock may sell-off into the correction in a downward direction for up to 20% to 35% off the previous swing high. The time frame for this correction is usually anything from 8 to 12 weeks depending on the general market conditions.

Once the correction is over, the stock again tries to recover and tries to retest the previous swing highs. But because in the correction the stock comes so much down from the previous highs, the stock will again incur selling power by the traders who were sitting caught near the last swing high. They saw a loss in their portfolio for so long time and tries to exit their losing position and get rid of the stock. This selling pressure will take the stock value to a small correction in a sideways style. This phase will last for roughly a few days to a few weeks.

Cup and Handle Pattern
Image source: YouTube

In the cup and handle pattern, the corrective trade typically takes place about 5% below the previous swing high. In case the stock is fundamentally weak, there are chances that the stock will fail to recover any further But if the fundamentals are good for the stock it exhibits a breakout from the pattern.

This is the time to buy the stock in the cup and handle pattern. It is because it emerges into new highs on the buying pressure on the euphoria of crossing the previous high that it could not cross in the last 8 to 12 weeks.

Example of the Cup and Handle Pattern

See the image below. This is the weekly chart of the Dhampur Sugar Mills. See the stock was in a consistent downtrend for many weeks. But then the stock has shown a rounding bottom. This has formed the cup. Now once it tried to reach the previous swing high it has undergone some short selling due to the traders locked it at these levels.

Cup and a Handle Pattern

Phases of the Cup and Handle Pattern

This pattern is divided into two phases. They are the Cup and the Handle. Let’s check the features of individual phases.

Cup

There are 3 parts of the cup. One is the left side, the bottom, and the right side. The left side of the cup is formed when a prolonged state of downtrend prevails. The downtrend ultimately slowly ends by forming the rounding bottom. Then a rally starts forming the right side of the cup.

Handle

Once the cup is formed, the intermediate uptrend ends and the market shows a halt. This can be a sideways phase too and slowly the market prepares to breakout. This is the handle and if the last swing high gets broken it is a breakout of the Cup and Handle Pattern.

Importance of Volume

There is an importance of volume in the pattern confirmation. Check the chart below. Sun TV has shown a typical Cup and Handle pattern. We can see a big volume bar indicated the bottom of the market. That is the point where sellers exited and buyers entered. Then we can see steady volume in the handle area showing traders’ interest in the stock and check the big rally after the pattern breakout.

Cup and Handle Pattern

This sell-off has formed the handle. Finally, the stock has seen a breakout from the cup and handle pattern and started a new rally on the weekly charts. You can see it was a massive rally that minted money for the traders.

Targets and Stop Loss of Cup and Handle Pattern

It is easy to calculate the target and stop-loss of this pattern. This is a very low-risk high gain trading pattern. First, calculate the depth of the cup. Now to calculate the target simply add this depth with the breakout point. Similarly, you can keep the stop-loss below the handle.

Targets and Stop Loss

In the chart above we can see the depth of the cup in Bajaj Finserve is 1961 points (round off to 2000 points). The breakout zone comes above the 8600 levels. So roughly this stock will have a breakout target of 8500+2000 = 10600. The lowest point of the handle is at 7850. So if traders buy this stock it will be the stop-loss.

So check how the risk-reward ratio of this pattern is highly favorable. If anyone buys Bajaj Finserve at 8600 they will have 10600 as target and 7850 as stop loss. That 2.5 times reward versus the risk. This makes this pattern also a favorite for the analysts.

Suggested Reading

Here we are providing you with a PDF guide to trade this Cup and Handle Pattern. This guide is taken from Stocks & Commodities magazine. You can unlock the download link below by using any social share buttons.

Conclusion

I’ve tested that probably the largest stock market winners come from this highly effective cup and handle pattern formation. This is one of the perfect and most dependable patterns to search for. We can identify many good stocks at the beginning of a fresh trend after a deep market correction. Most of these stocks show a tremendous rally after the breakout of this pattern.

Author: Indrajit Mukherjee

Indrajit is a professional blogger and trading system developer. Amibroker expert, Wordpress expert, SEO expert and stock market analyst.Trading since 2002, he has started the journey of StockManiacs.net on 2008. He follows Indian and world stock markets closely.

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