Cup and Handle
The cup and handle pattern occurs during an uptrend. The cup portion of the cup and handle pattern is a retracement from the previous uptrend and occurs when prices gently fall, then bottom, and then gently rise again forming a long term letter "U". The handle portion is a retracement downward from the right side of the cup (called the lip) and then a reversal upward toward the price level of the top of the left side of the cup; it is usually sharper like the letter "V" and does not fall in distance as far as the cup portion falls. A buy signal is triggered when prices surpass the high of the right side of the cup.
TimeSpans of an Average Cup and Handle Pattern
Height Averages of the Cup and Handle Pattern
According to William O'Neil (2002), the cup and handle pattern usually forms prior to an uptrend of 30% or more and takes between seven and 65 weeks to form, but the majority are three to six months; in addition, the distance between the top of the cup and the bottom of the cup is 12% to 15% but can be up to 33% (p. 124). Kirkpatrick & Dahlquist state that typically volume decreases on the left side of the cup and then increases on the right side of the cup (2010, p. 325).
Average Maximum Gains after Breakout
Bulkowski's (2005) research suggests that the averaged maximum rise after the breakout of the cup and handle pattern is 34%. Bulkowski (2008) also gives price targets for the cup and handle breakout:
Psychology of Cup and Handle Pattern
The psychology of the cup and handle pattern is as follows: The "U" part of the cup is where prices slowly fall, this wears out speculators. This is usually illustrated be a decrease in volume on the left side of the cup. Once prices reach a level where institutions and strong hands find value, they will begin to accumulate the stock, shown by an increase in volume. However, once prices reach the levels of the left side of the lip of the cup that acts as an area of resistance, traders begin to sell. This selling creates the handle portion of the pattern. Traders attempt yet again to reach the resistance area that is the price level of the lip of the cup. If prices surpass this resistance area, then a multi-month long consolidation is over and prices are free to continue their rise. This breakout also gathers the attention of momentum traders who bring in even more volume to add strength to the breakout. However, if prices failed to breakout, then a solid area of resistance that has been tested three times now and has held has been established which is very bearish for the chart.
Inverse Cup and Handle
The other variant of the cup and handle is the inverse cup and handle. The trend direction prior to the pattern can either be upward or downward. Bulkowski (2005) explains that, contrary to expectation, with the inverse cup and handle, prices actually rise prior to the pattern over half of the time. Thereafter prices rise gently and slowly create a curved top and then gently move back down creating a long term dome "n". The handle portion is a retracement upward from the right side of the cup (called the lip) and then a reversal downward toward the price level bottom of the left side of the cup's lip; it is usually a sharper peak like the caret symbol "^" and does not rise in distance as far as the cup portion's highest high. A sell signal is triggered when prices surpass the low of the bottom of the right side of the cup (i.e. its lip).
Inverse Cup and Handle Sell Signal
According to Bulkowski (2005), the averaged maximum decline of the inverse cup and handle is 16%.
Chart Example of Cup and Handle
The chart above of the Gold ETF (GLD) illustrates an uptrend prior to the pattern, then a downtrend that bottoms out creating the left side of the cup and then a slow ascent creating the right side of the cup. Prices then break the uptrend established by the right side of the cup, thus creating the handle. Prices reverse in a "V" formation rising until the high established by the right side of the cup. Once that high is pierced, prices continued to rise.
Chart Example of the Inverted Cup and Handle
The chart above of the Utility SPDR ETF (XLU) illustrates an inverse cup and handle. After a downtrend, prices reverse in a gentle dome formation creating the cup. Prices change direction by retracing upward and then falling back to the support price level established by the low of the right lip of the cup. Once prices penetrate the low of the right lip of the cup, then a sell signal is triggered and in the chart above prices fall thereafter.
Source: O'Neil, W. (1992) How To Make Money In Stocks: A Winning System in Good Times or Bad, 3rd Edition. New York: McGraw-Hill.
Works Referenced
- Kirkpatrick II, C.D., & Dahlquist, J.R. (2010). Technical Analysis: The Complete Resource for Financial Market Technicians (2nd ed.). Upper Saddle River, NJ: FT Press.
- Rockefeller, B. (2011). Technical Analysis For Dummies (2nd ed.). Hoboken: John Wiley & Sons.
- The Pattern Site. (2008). Bulkowski's Measure Rule. Retrieved June 1, 2012, from http://thepatternsite.com/measure.html
- The Pattern Site. (2005). Bulkowski's Cup with Handle . Retrieved June 1, 2012, from http://www.thepatternsite.com/cup.html
- The Pattern Site. (2005). Bulkowski's Inverted Cup with Handle . Retrieved June 1, 2012, from http://www.thepatternsite.com/icup.html
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