The cup and handle pattern is common on bar charts. It’s a continuation chart pattern that occurs after a long-term downtrend or a correction.
The cup usually shows that the market may be bottoming since it has left the lows and is making higher highs toward resistance, while the handle shows a tight consolidation formed under resistance.
How does the cup and handle pattern work?
Traders have to check to see how price deviates at resistance because it shows whether selling pressure is lurking around. A large sell-off from resistance tells traders two things: the pattern is no longer valid and shows that the market is ready to go lower.
If traders see that price is holding up at resistance, it means that buyers are satisfied with the high prices and are willing to buy them. The moment price breaks out of resistance, it confirms the cup and handle pattern and the market could be about to move higher.
It’s important to note that the best cup and handle patterns will have a shallow retracement on the handle.
The illustration below shows how the cup and handle pattern looks on a chart.
How do you trade with the cup and handle pattern?
Before traders enter a trade with the cup and handle pattern, they have to consider whether they should place a buy stop order and whether they should wait for the candle to close.
When traders place a buy stop order, their entry will be above the highs of the handle. If the breakout is real, it’s one of the best prices to get. However, if it’s a false breakout, traders buy the highs.
The second approach, waiting for the candle to close, is a good one to adopt because it’s less prone to false breakouts. However, the market may close much higher, which means that traders get a poor entry point. This results in a wide stop loss and a smaller position size on the trade.
Traders can go with any method they are most comfortable executing because there will be fewer errors and more consistency in the long run.
To exit trades, traders should use the moving average or structure to ride big trends.
The image below shows how the price breaks resistance after the third touch, confirming the cup and handle candle pattern.
How to use the moving average with the cup and handle
With a moving average, traders will notice that price remains above the indicator for a long period. Therefore, they can trail their stop loss as the price stays above the MA and exit the trade where the price closes below the MA.
Traders can use the 200-period MA for long-term trends, the 100-period MA for medium-term trends, and the 20-period MA for short-term trends.
The image below shows the reversal of the cup and handle pattern.
How to use structure
Candles make higher highs and lows to continue in an uptrend; if that doesn’t occur, it means the price is about to reverse lower, or it's in a range market.
With this idea, traders can trace their stop loss on the initial swing low. If the price wants to continue in an uptrend, it won’t break the previous swing low.
Before the swing low, traders can give their stop loss a cushion if they don’t want price to breach the lows and only reverse higher. Traders who don’t like to ride trends can capture a swing for huge profits.
How to get a swing for consistent profits
A swing involves getting a move in the market. Traders exit their trades before the opposing pressure occurs. For example, if traders buy, they exit the trade before the swing high or resistance; they exit a sell before a swing low or support.
Traders who prefer chart patterns exit a trade when the pattern is complete. The best way for traders to know when the pattern is complete is by using the price projection technique.
All they need to do is know the distance from the high of the cup to the low, then determine the distance from the breakout point to determine their target profit.
The bottom line
The cup and handle is a bullish reversal pattern that traders can use to make consistent profits.
It’s essential for a trader to know that the pattern has downsides, like the fact that it can result in late decisions due to a delay in the full formation of patterns or the false signal it produces when a deep cup pattern forms.
Therefore, it’s wise to trade the cup and pattern with other strategies and indicators, such as the moving average.