The cup with handle pattern is a forex chart formation that's well-known as a signal foreshadowing an upward price continuation following market hesitation, and a test toward a possible downward move. The first observation of the formation is attributed to publisher William O'Neil, the founder of Investor's Business Daily, who originally described the pattern in the 1980s.
Bottoms Up: A Cup Of Cheer
The cup with handle formation may seem peculiar and less obvious than some of its counterparts, such as the double or triple bottoms that show more linear components. The pattern typically begins following an upward price trend, with a downward price movement (the left side of the "cup") showing a decline in conviction among investors and bearish sentiment winning out over bullish buying.
The price decline and then begins to decelerate and flatten out in the middle of the pattern, as bearish sentiment weakens and bulls go to work against possible further price declines. After the price flattens out, bulls regain the upper hand and price begins to gradually move upward. This culminates in a sharp upward movement that forms the right side of the cup.
It's important that the bottom of the cup pattern appears as a U-shape, because if the pattern appears in a V-shape, a subsequent breakout is less likely to prosper. Once the formation reaches the level of the previous high seen at the left side of the cup or even slightly higher, the price will flatten out into a slightly downward but mostly horizontal "handle," showing some hesitation among investors about the continued strength of the upward movement.
The formation of the handle is an important detail that will determine the strength and likelihood of a further move upward. Generally, the handle may move downward to about one-third of the height of the cup formation to be considered a continuation signal. However, it shouldn't move to more than one-half the size of the cup formation. A shallower and longer handle is seen as a stronger signal of an impending upward breakout, because it gives time to shake out any traders who lack conviction of a further upward move.
As with most breakout patterns, it's important to monitor the volume of trading to help confirm the various components of the cup with handle. This is especially important at the end of the pattern when the handle forms. At the point of the breakout and once the end of the handle is reached, volume will spike to around 50% above the 50-day average.
How To Trade The Cup With Handle
The formation of the handle offers traders an opportunity to prepare for a breakout upward into the continuation of the trend that was in effect before the formation of the cup pattern. Once the cup pattern forms, traders can look to place a protective stop below the handle at a one-third or one-half retracement of the cup.
A profit target can be set above the cup at twice its height. A strong pick-up in volume will serve as an entry signal for the trade, and a good entry point can be slightly above the highest point of the handle.
A Variation On The Theme?
At times, the cup with handle may not form, and only the cup portion appears. The cup signal, however, is essentially the same as the cup with handle. The main difference is that the entry point for a trade will be different. In the case the right portion of the cup formation extends above the left without flattening to a handle, traders can enter the trade shortly thereafter upon a strong surge in volume.
The cup with handle has been found to be a reliable indicator of a bullish trend continuation. One special advantage of the formation is that it can allow traders time to pause and set up well-positioned entry and exit points for a bullish breakout once the pattern begins to emerge. As with analysis of all chart patterns, it requires special attention to price movements and volume signals before a successful trade can be carried out.
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Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…