What is a cup and handle model?
A cup and handle price pattern on a security’s price chart is a technical indicator that looks like a cup with a handle, where the cup is shaped like a “u” and the handle has a slight drift down.
The cup and the handle are seen as a bullish signal, with the right side of the pattern typically seeing lower trading volume. Model training can be as short as seven weeks or as long as 65 weeks.
Key points to remember
- A cup and handle is a technical chart pattern that looks like a cup and handle where the cup is shaped like a “u” and the handle has a slight downward drift.
- A cup and a handle are considered a bullish signal extending an uptrend, and they are used to spot opportunities to go long.
- Technical traders using this indicator should place a buy stop order slightly above the upper trendline of the handle portion of the pattern.
- The pattern was first described by William J. O’Neil in his classic 1988 book on technical analysis, How to make money with stocks.
What does a cup and handle pattern tell you?
American technician William J. O’Neil defined the cup and handle (C&H) pattern in his 1988 classic, How to make money with stocks, adding technical requirements through a series of articles published in Investor’s Business Daily, which he founded in 1984. O’Neil has included time measurements for each component, as well as a detailed description of the rounded dimples that give the design its unique teacup appearance.
As a stock forming this pattern is testing former highs, it is likely to come under selling pressure from investors who have previously bought at these levels; selling pressure is likely to cause prices to consolidate in a downtrend direction for a period of four days to four weeks, before moving higher. A cup and handle is considered a bullish continuation pattern and is used to identify buying opportunities.
Consider the following when detecting cup and handle models:
- Length: Generally, cups with longer, more “U” shaped bottoms provide a stronger signal. Avoid mugs with sharp “V” bottoms.
- Depth: Ideally, the cut should not be too deep. Avoid handles that are too deep as well, as the handles should form in the top half of the cup design.
- Volume: Volume is expected to decline as prices decline and remain below average in the base of the bowl; it should then rise as the stock begins to rise, rising again to test the previous high.
A retest of the previous resistance is not necessary to touch or be within a few ticks of the old high; however, the farther the top of the handle is from the treble, the greater the breakout should be.
How to swap cup and handle
There are several ways to approach cup and handle trading, but the most basic is to look to enter a long position. The image below depicts a classic cup and handle formation. Place a buy stop order slightly above the upper trendline of the handle. Order execution should only take place if the price breaks the resistance of the pattern. Traders can experience excessive slippage and enter a false breakout using an aggressive entry.
Alternatively, wait for price to close above the upper trendline of the handle, then place a limit order slightly below the pattern breakout level, trying to get a fill if price comes back. There is a risk of missing the trade if the price continues to advance and does not retreat.
Image by Julie Bang © Investopedia 2020
A profit target is determined by measuring the distance from the bottom of the cup to the breakout level of the pattern and extending that distance upwards from the breakout. For example, if the distance between the bottom of the cup and the breakout level of the handle is 20 points, a profit target is placed 20 points above the pattern handle. Stop-loss orders can be placed below the handle or below the cut depending on the trader’s risk tolerance and market volatility.
Example Swap cup and handle
Now consider an actual historical example using Wynn Resorts, Limited (WYNN), which went public on the Nasdaq stock exchange near $13 in October 2002 and rose to $154 five years later. The ensuing decline ended within two points of the initial public offering (IPO) price, far exceeding O’Neil’s requirement for a shallow cut high in the previous trend. The subsequent wave of recovery reached the previous peak in 2011, almost 10 years after the first impression.
The handle follows the classic pullback expectation, finding support at the 50% retracement in a rounded shape, and returns to the high for the second time 14 months later. The title broke in October 2013 and added 90 points over the next five months.
Image by Julie Bang © Investopedia 2020
Cup and Handle Model Limitations
Like all technical indicators, the cup and handle should be used in conjunction with other signals and indicators before making a trade decision. More specifically, with the cup and the handle, certain limitations have been noted by practitioners. The first is that fully training the model can take some time, which can lead to late decisions. While a month to a year is the typical time frame for a cup and handle to form, it can also happen quite quickly or take several years to establish, making it ambiguous in some cases.
Another issue is the depth of the cup portion of the formation. Sometimes a shallow cup can be a signal, while other times a deep cup can produce a false signal. Sometimes the cup forms without the characteristic handle. Finally, a common limitation of many technical models is that it may not be reliable in illiquid stocks.
What does a cup and handle pattern indicate?
A cup and handle is a technical indicator where the price movement of a security resembles a “cup” followed by a downward price trend. This drop, or “manipulation”, is meant to signal a buying opportunity to stay long on a security. When this part of price formation is complete, the stock can reverse course and reach new highs. Typically, cup and handle models range from seven weeks to over a year old.
How do you find a cup and handle model?
Consider a scenario in which a stock recently peaked after a significant momentum, but has since corrected, falling almost 50%. At this point, an investor may buy the stock, anticipating that it will rebound to previous levels. The stock then rebounds, testing previous high resistance levels, after which it falls into a sideways trend. In the final leg of the setup, the stock breaks through these resistance levels, rising 50% above the previous high.
What happens after a cup and handle model is formed?
If a cup and a handful forms and this is confirmed, the price should see a strong increase in the short to medium term. If the pattern fails, this bull run would not be observed.
What is the target for the cup and handle model?
The target with the cup and handle model is the height of the cup added to the break point of the handle. Generally, these patterns are bullish signals extending an uptrend.
Is a cup and handle pattern bullish?
Typically, cup and handle patterns are bullish price formations. The founder of the term, William O’Neil, identified four main stages of this technical business model. First, about one to three months before the “cut” pattern begins, a security will hit a new high in an uptrend. Second, the stock will come back, losing no more than 50% from the previous high, creating a rounded bottom. Third, the stock will rebound to its previous high, but then decline, forming the “sleeve” part of the formation. Finally, the title erupts again, overshooting its highs which are equal to the depth of the cup’s low point.