New Ways to Trade the Cup and Handle Pattern

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New Ways to Trade the Cup and Handle Pattern

What Is the Cup and Handle Pattern?

In his 1988 book “How to Make Money in Stocks,” American entrepreneur William J. O’Neil developed the cup and handle (C&H) pattern, adding technical criteria in a series of articles published in Investor’s Business Daily, which he launched in 1991. O’Neil supplied time frame data for each component, as well as a full explanation of the pattern’s rounded lows, which give it a teacup look.

Key Takeaways

  • In his 1988 bestseller, “How to Make Money in Stocks,” American entrepreneur William J. O’Neil established the cup and handle (C&H) pattern.
  • O’Neil then expanded on the pattern’s technical requirements in a series of essays published in Investor’s Business Daily, which he started in 1991.
  • The pattern’s first and second phases are as follows: the security makes a notable high in an uptrend that accelerated between one and three months ago, and the subsequent decline carves out a rounded bottom no deeper than the 50% retracement of the preceding trend. This represents the “cup.”
  • The pattern’s third and fourth stages are as follows: the next breakout attempt fails at the prior high, resulting in a secondary pullback that holds near resistance, grinding out a smaller rounding bottom that becomes the “handle,” and the security returns to resistance for the second time and breaks out, yielding a measured move target equal to the depth of the cup.
  • William O’Neil’s initial stringent specifications for the cup and handle pattern, established more than 30 years ago, may now be stretched into a variety of market conditions and time periods.

Understanding the Cup and Handle Pattern

O’Neil defined the phrase by pointing to four phases in acup and handle breakout:

  • The security reaches a new high in an uptrend that began between one and three months ago.
  • The following downturn carves out a roundingbottom no deeper than the last trend’s 50% retracement. This represents the “cup.”
  • The next breakout attempt at the previous high fails, resulting in a secondary retreat that remains around resistance, grinding out a smaller rounded bottom that forms the “handle.”
  • The security returns to resistance for the second time and breaks out, resulting in a measured move target equal to the cup’s depth.
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Many cup and handle traders closely follow O’Neil’s construction principles, but there are other modifications that achieve consistent outcomes. In reality, modified C&H patterns may be used for anything from intraday scalping to monthly market timing. Finding and trading these updated versions requires an awareness of crowd psychology at disputed price levels, as well as a trained eye capable of seeing through greater noise levels caused by electronic stops in the current marketplace.

The cup and handle chart pattern is one of several that traders may utilize to influence their approach.

Deconstructing the Cup and Handle

Consider the market dynamics of a common cup-and-handle situation. A fresh rally prints a high, and the price rolls over into a decline, converting relative strength oscillators into sell cycles that push longs to leave. New buyers join the decline at the 38.6% or 50% retracement level, anticipating that the previous rise would restart. The stock rebounds and tests the high, attracting aggressive short sellers who predict that a fresh downturn would result in a double top collapse.

That rebound movement may conclude at or surpass the original high by a few points before reversing, adding downward fuel since it traps two sets of buyers. First, longs who enter the pattern deep feel worried since they were counting on a failed breakout. Longs pursuing the breakout, on the other hand, see a little profit disappear and are forced to protect holdings. Both groups are now being targeted for losses or decreased earnings, while short-sellers congratulate themselves on a job well done.

When the drop pauses high in the wide trading range, the tables shift once again, allowing for narrow sideways activity. Short sellers lose confidence and begin to cover, giving gasoline to the upward, while strong-handed longs who weathered the recent drop gain confidence. Relative strength oscillators have now entered fresh purchase cycles, prompting a third group of longs to take risks. Price rises into resistance, completing the third leg of the pattern, and breaking out in a powerful upswing, triggering a positive feedback loop.

Because crowd psychology shows fractal features, carrying out comparable emotional behavior inside greater and smaller time frames, deconstructed mechanics instruct us to seek for the C&H pattern in places William O’Neil never envisaged, including 60-minute and monthly charts. It also implies that rounded bottoms are unnecessary as long as other structural aspects attract fresh buyers and dissuade short-sellers, causing them to cover holdings.

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With that in mind, consider three cup and handle designs that do not fit the traditional template.

Multi-Year Cup and Handle

Image by Sabrina Jiang © Investopedia2020

Wynn Resorts, Limited (WYNN) went public on the Nasdaq market in October 2002 for about $11.50 and increased to $164.48 five years later. The ensuing drop finished within two points of the IPO price, greatly surpassing O’Neil’s threshold for a shallow cup high in the previous trend. The ensuing rebound wave peaked in 2011, roughly four years after the first print. The handle follows the conventional pullback pattern, establishing support around the 50% retracement in a rounded shape, and then returning to the high 14 months later. The stock broke out in October 2013 and gained 90 points in the five months that followed.

Cup and Odd Handle

Image by Sabrina Jiang © Investopedia2020

In 2014, Microsoft Corporation (MSFT) manufactured two unconventional cup and handle designs. It reached a high of $41.66 in April before retracing to the 38.6% retracement of the previous trend leg. Price formed a jagged but rounded bottom at that level before returning to the June high. It then grind sideways in a consolidation pattern (first blue box) for more than five weeks, or about half the time it took to finish the cup piece.

According to O’Neil’s description, the handle should be no more than one-fifth to one-quarter the length of the cup. This handle may not resemble the ideal pattern, but it fulfills the same function by remaining near to the previous high, shaking off short sellers, and encouraging fresh longs to initiate positions. It is worth noting that a deeper handle retracement, whether rounded or not, reduces the likelihood of a breakout since the price structure strengthens resistance near the preceding high.

In July 2014, the security eventually broke out, with the uptrend matching the length of the cup in a well measured move. The rally peak produced a new high, resulting in a retreat that was substantially similar to the previous pattern, retracing 50% of the earlier gain. This time, the cup prints a V-shaped bottom rather than a rounded bottom, with the price remaining below the previous high. For the next three weeks, it grind sideways in a spreading configuration (second blue box) that looks nothing like the typical handle before breaking out. This rally fell short of the measured move objective of $50, which was derived by adding the cup’s four-point depth to the resistance line around $46.

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Intraday Cup and Handle

Image by Sabrina Jiang © Investopedia2020

When trying to purchase a larger-scale trend that does not indicate a low-risk entry price on the daily or weekly chart, the 60-minute cup and handle pattern is an excellent timing tool. After pulling back to significant support at the 200-day exponential moving average, Akamai Technologies, Inc. (AKAM) consolidated below $62. (EMA).In early February 2015, it returned to resistance and fell into a little rectangle pattern with support at $60.50. This rectangle handle remained far above the 38.6% retracement level, allowing bulls to maintain control ahead of a breakout that surpassed the measured move goal and printed a 14-year high.

The Bottom Line

William O’Neil’s tight specifications for the cup and handle pattern, which he established more than 20 years ago, may now be stretched into other market conditions and time periods. This larger perspective enables us to move our emphasis away from the classic pattern’s official definition and toward the crowd psychology that drives its ability to anticipate large breakouts.

Investopedia does not provide tax, investment, or financial advice. The material is offered without regard for any individual investor’s investing goals, risk tolerance, or financial circumstances, and may not be appropriate for all investors. Investing entails risk, including the possibility of losing money.

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