Cup and Handle Pattern in Technical Analysis [Trading Guide]


Chart Patterns are commonly leveraged by technical traders across all asset classes to predict the future movement in price trends. One prominent chart pattern that traders use is the Cup and Handle Pattern. The pattern gets its name from its appearance that resembles a teacup with a handle. Alongside other popular chart patterns, the frequent appearance of the Cup and Handle Pattern interestingly demonstrates that despite a magnificent technological revolution in the recent past, human trading decisions and markets have not drastically changed psychologically over time.   

So, what exactly is a Cup and Handle Pattern? The Cup and Handle Pattern is a popular bullish chart pattern that, depending on its position on the price chart, could indicate a reversal or a continuation in price trend. In an uptrend, the pattern suggests a momentary consolidation before the resumption of the prevalent trend. Contrarily, in a downtrend, the pattern signals a potential reversal. By appearance, the pattern resembles a teacup with a handle and is accordingly named. 

In technical analysis, the appearance of the Cup and Handle Pattern is considered a “bullish signal”. Because of this, the pattern is often used to spot opportunities for going long in the market. In the remainder of this article, we will discuss various types of the Cup and Handle Pattern, how to identify and interpret it, and how effective it is in trading, and what can be done to improve its reliability in trading.

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Types of the Cup and Handle Pattern 

There are two main variations of the Cup and Handle Pattern worth noting. These are – 

  • Regular Cup and Handle Pattern
  • Inverted Cup and Handle Pattern

In the following sections, we will briefly discuss both these pattern types and understand the key differences between the two.

Regular Cup and Handle Pattern

The Regular Cup and Handle Pattern is what we commonly refer to as simply the Cup and Handle Pattern. The pattern can appear in a downtrend or an uptrend, but irrespective of the direction of the prevalent trend, the Regular Cup and Handle Pattern always signals the potential emergence/continuation of a bullish trend. 

That being said, the market psychology forces that lead to the development of this pattern are different in an uptrend versus a downtrend. However, this has no implications on the directional guidelines on the future price action that the pattern indicates or on the strategies that you leverage for trading this pattern. 

Overall, the pattern resembles the look of a teacup with a handle and is regarded as a reliable signal to prompt bullish trades in most trading circles. 

Inverted Cup and Handle Pattern

In essence, the Inverted Cup and Handle Pattern is the reverse of the Regular Cup and Handle Pattern. Be it the psychological forces leading to the creation of this pattern, or merely the pattern’s appearance, the Inverted Cup and Handle Pattern, in essence, is the mirror image of its regular cousin. 

So, what exactly is an Inverted Cup and Handle Pattern? The Inverted Cup and Handle Pattern is a bearish chart pattern that resembles the look of a teacup with handle placed upside down. Depending on the direction of the prevailing trend, the pattern could indicate a bearish reversal or a bearish continuation. In an uptrend, the pattern signals a bearish reversal, whereas, in a downtrend, it indicates a bearish continuation.  

Similar to the Regular Cup and Handle Pattern, the market forces leading to the development of this pattern are different in an uptrend versus a downtrend. However, this has no implication on the directional prediction of future price action that the Inverted Cup and Handle Pattern indicates and the strategies that you can implement to trade this pattern. Overall, in most technical and pattern trading circles, the pattern is well regarded as a reliable sign of upcoming bearish price action. 

Finally, even though this article particularly focuses on the Regular Cup and Handle Pattern, everything discussed here can be applied, but in reverse, for trading the Inverted Cup and Handle Pattern as well. 

Identifying Cup and Handle Pattern

Spotting the Cup and Handle Pattern on the price chart of a security can be simple for experienced pattern traders. However, to the eyes of a novice or less experienced trader, identifying this pattern is no easy feast. 

There are two methods to correctly identify and to confirm the Cup and Handle Pattern in a timely fashion. These are – 

  • With Geometry and Shape Recognition
  • With the Use of Technical Indicators and Tools

For accurate predictions, you should use both these above-stated methods in combination with one another when identifying the Cup and Handle Pattern. 

Now, without further ado, let us dive deep into both these methods in the following sections.

Identifying Cup and Handle Pattern Using Geometry and Shape Recognition

In essence, the Cup and Handle Pattern graphically depicts four phases in the price change of an asset. 

Preceding the pattern is a period of strong trend, which could be either bullish or bearish. Post that, once the pattern begins to form, in the case of an uptrend, the price of the security starts to fall; whereas, in the case of a downtrend, the price fall begins to lose its momentum. This movement in price takes a downward sloping shape, and thus completes the first phase of pattern development. 

Next, this downward sloping price gradually hits a lower limit, becoming flat. This gives shape to the bottom of the Cup and marks completion to the second phase of the pattern. 

Following this, the price of the security starts to rise again. Geometrically speaking, this upward slope of the price move is symmetrical and roughly a mirror image to the downward price slope during the initial phase of pattern development. 

Together, these three price movements stated above – the downward slope in price, followed by a flat price range, which in turn is followed by an uptrend – completes the “Cup” part of the pattern. 

However, the uptrend established during the third phase of pattern development is short-lived. This is because this uptrend fails to break past a resistance point, and instead of continuing upward, the price plummets back into a downward consolidation, thereby creating the “handle” portion of the chart pattern. This completes the overall construction of the pattern. 

Therefore, to summarize, there are four key structural components to the Cup and Handle Pattern, using which it can be identified on the price chart of a security. These are –

  • The Downward Slope: The construction of the patterns begins with the price pulling back from an ongoing uptrend, or the price losing its downward momentum in the case of a prevalent downtrend. Hence, for a Regular Cup and Handle Pattern, a downward sloping price curve marks the beginning of the pattern.
  • The Bottom: When the downward sloping price curve of the pattern hits a lower limit, the bottom of the cup is formed. This is characterized by a very brief period of flat movement in price before it begins its upward trajectory. 
  • The Upward Slope: Slightly after the lower limit is hit, the price reverts back on an upward trajectory towards the level at the beginning of the downward slope. This movement of price forms the second half of the pattern curve, and thereby completes the construction of the “Cup”. 
  • The Handle: The upward slope in price movement that leads to the completion of Cup formation fails to break past a resistance point. As a result, it consolidates taking the shape of a downward sloping line that resembles the shape of a “handle”. This phase marks the completion of the Cup and Handle Pattern, post which the bullish trajectory of price continues. 

NOTE: Even though not a structural component to the Cup and Handle Pattern, a strong trend (bullish or bearish) is critical to the formation of the Cup and Handle Pattern. This is because this prevailing trend has a bearing on market psychology that leads to the development of this pattern. More on this subject will be covered during the interpretation section of the pattern.  

Identifying Cup and Handle Pattern Using Technical Indicators and Tools

Given its unique structural composition, the Cup and Handle Pattern may be inherently simple to identify on a candlestick trading chart. However, with the help of several technical indicators and tools, identifying this pattern can be further simplified. 

Listed below are several technical analysis tools that can be leveraged to correctly identify the Cup and Handle Pattern in a timely and accurate manner – 

  • Price Action Structures: In essence, price action structures are simple markings or drawings, such as – trendlines, on a security’s price chart. As noted above, to correctly identify the Cup and Handle Pattern, you would need to identify its four phases of development. Markings and drawings will isolate a potential chart pattern that is in the early stages of development from the rest of the price chart, and make it easily recognizable. Therefore, trendlines and other similar price action structures are considered the most basic but effective tools in identifying and confirming the formation of Cup and Handle Patterns. 
  • Volume Indicators: Trading volume plays a vital role in the development of various chart patterns, and is, therefore, an effective tool for confirming their presence. In the case of a Cup and Handle Pattern, the volume will spike at the lowest point of the cup as numerous exits and entries are made, and again at the final breakout from the handle; this point is meant to give price the momentum to be able to revert from the handle and enter an uptrend. As a quick gist, you must remember that every time a Cup and Handle Pattern develops, it represents a specific pattern of changing trading volume. You can read these volume patterns using indicators such as the Average Directional Index (ADX) and Volume Price Trend (VPT), and use it to confirm the formation of the Cup and Handle Pattern.

Interpreting Cup and Handle Pattern

The Cup and Handle Pattern may seem like a simple chart pattern formed as a result of the herd mentality that exists in the capital markets. But, carefully reading this pattern may provide some very useful insights on the future price performance of the security that you are trading.

To simplify, the insights revealed by the Cup and Handle Pattern can be broken by three main characteristics of the pattern – 

  • Structure of Cup
  • Structure of Handle  
  • Duration of Pattern Construction

Now, without further ado, let us discuss each of these three characteristics of the Cup and Handle Pattern to fully understand how you can interpret these while making trading decisions.

Structure of Cup 

The structure of the “Cup” portion of the pattern reveals important information with regards to the market’s interaction with the asset. This is because the Cup of the pattern can take several different shapes depending on the relative duration over which it is formed. 

Described below are the two shapes the Cup of the pattern can take and what it would mean for you as a trader –

  • A V-shape Cup implies the price is rebounding, but the reversal is too sharp and does not indicate any near term stability. In such situations, it is often too difficult to trade or make any near term predictions on the price performance of the assets. Therefore, such Cup and Handle Patterns, where the cup of the pattern takes a V-shape are best to avoid as the trading signals generated by them are not very reliable. 
  • When the Cup is rounded or U-shaped, it indicates that a consolidation is possible. In other words, although the price is on a decline initially, the gradual U-shape is said to wear out speculators and weak security holders, leaving a more stable demand behind. Ideally, for the trading signals generated by the Cup and Handle Pattern to be accurate, the Cup portion of the pattern should be U-shaped and shallow relative to the price trend that preceded it. 

Therefore, in essence, the U-shape represents a change in psychology amongst institutional security holders where the short-term profit-oriented investors will leave, and only keen owners with no intentions of selling will remain in the market.

Structure of Handle

Before the formation of the handle, the Cup and Handle Pattern could easily be confused for a Rounded Bottom Pattern. The handle can also vary in slope and in length. However, the downtrend should not exceed the mid-point of the distance between the base of the Cup and the breakout point. In fact, in most cases, the Handle would not exceed beyond one-third of the distance between these two points.

When the Handle portion does exceed this one-third mark, the likelihood that the price will be able to bounce back again gets reduced considerably. Essentially, this can be seen as an indication that the downtrend will continue, and that the anticipated rebound will not occur.

Contrarily, a shorter Handle with a smaller slope (causing sideways action instead of a sharp downtrend) is a good indicator that the price will revert, and the breakout will be very bullish.

Duration of Pattern Construction

In the construction of a Cup and Handle Pattern, the time that it takes for the pattern’s base to form can be very variable. Depending on the timeframe that you are trading in, the construction of the pattern’s base can take anywhere between several hours to several months to complete.

However, for a Cup and Handle Pattern to be reliable, the duration of the price trend preceding the pattern should be at least as long as the time it took for the pattern construction to complete. When that is not the case, you should trade the pattern with caution. In fact, in most scenarios, such Cup and Handle Patterns are best left untouched, as the accuracy of the trading signals generated by them can be really low.  

Improving Reliability of Cup and Handle Pattern in Trading

The Cup and Handle Pattern is quite reliable at informing trading decisions but it does come with its own set of limitations. Several limitations of this pattern that can impact the accuracy of the trading decisions made using it are as follows – 

  • There is ambiguity over time that it can take for the pattern to form. This poses challenges for traders in identifying a true Cup and Handle Pattern. 
  • Determining the length and depth of a genuine Cup and Handle Pattern can be challenging. This can potentially result in the generation of false signals for the traders. 
  • Even though some inferences can be made on the volatility of the market based on the shape of the pattern and the time that it took for the pattern to completely develop, the Cup and Handle Pattern gives no direct signal on how volatile an asset is. 

Due to these above-stated limitations, the trading decisions that are made solely using the Cup and Handle Pattern are not always accurate. Besides avoiding to trade on the Cups that are not U-shaped enough and on Handles that go down a bit too deep, the reliability of the Cup and Handle Pattern in trading can be considerably improved by combining it with other complementary trading tools.  

Listed below are several tools in technical analysis that complement the trading signals from the Cup and Handle Pattern, and can therefore be used to improve its reliability – 

  • Japanese Candlestick Patterns
  • Volatility Indicators (such as Donchian Channels)
  • Momentum Oscillators 

Now, let us briefly discuss how you can integrate each of these three tools within your strategy to trade the Cup and Handle Pattern, and improve the accuracy of your trading decisions. 

Japanese Candlestick Patterns

Japanese Candlestick Patterns are perhaps the most widely used analysis tools in technical trading today. When trading a Cup and Handle Pattern, you can leverage these patterns as confirmation signals for your trade entries and exits. 

Depending on the market psychology they represent, the candlestick patterns are classified into two broad categories – the Reversal Candlestick Patterns and the Continuation Candlestick Patterns. The Reversal Candlestick Patterns signal a potential reversal in the price trend, whereas, the Continuation Candlestick Patterns indicate that the continuation of the prevalent price trend is likely. 

Hence, depending on the direction of the trade that you are evaluating and the prevalent price trend, various candlestick patterns can further inform your trading decision, thereby improving its reliability.

Volatility Indicators

Market volatility is an important parameter that in a way helps determine how risky a potential investment might be. In essence, being able to see the volatility of the asset will allow you to assess whether the market fits into the risk profile that you are comfortable with. Therefore, it is an important parameter that you must consider as part of your overall investment and trading strategy. 

That being said, as stated above, even though you can make some inferences with regards to the volatility of an asset, the Cup and Handle Pattern does not directly reveal any information on market volatility. Therefore, to compensate for this weakness, you may benefit from adding a volatility measuring indicator to your chart pattern trading strategy. 

Examples of volatility indicators that integrate well into the Cup and Handle Pattern trading strategies include the Donchian Channel Indicator, the Bollinger Bands Indicator, and the Keltner Channel Indicator, etc.

Momentum Oscillators

In essence, Momentum Oscillators are the technical indicators that help identify whether an asset is in an overbought or oversold condition. Similar to the candlestick patterns, signals from these indicators, therefore, serve as great confirmation tools when trading the Cup and Handle Pattern. 

While, depending on your individual trading strategy, there are multiple ways in which Momentum Oscillators can be leveraged in trading chart patterns, divergence is broadly considered to be one of the most reliable confirmation signals that these indicators generate. Hence, by looking for divergence on the price chart of the security that you are trading, you can sizably improve the reliability of trading decisions.

Examples of Momentum Oscillators that work well with the Cup and Handle Pattern include the RSI (Relative Strength Index) Indicator, MACD (Moving Average Convergence Divergence) Indicator, Stochastic Oscillator, and Williams %R.

Trading Cup and Handle Pattern

Now that we have discussed the basic structure of the Cup and Handle Pattern, different methods to identify it, and various approaches to improve its reliability in trading, let us get to the fun part and understand how you would actually trade using this pattern. 

Even though there are several different approaches to trading the Cup and Handle Pattern, the Breakout Trading Strategy to trade it is considered to be the most reliable one in most trading circles. With the Breakout Trading Strategy, there are four stages to trading the Cup and Handle Pattern. These are – 

  1. Identifying Tradable Wave
  2. Determining Trade Entry
  3. Determining Stop Loss Level
  4. Determining Take Profit Level 

Now, without further ado, let us dive deep into each of these four stages in the following sections. 

Identifying Tradable Wave

The Cup and Handle Pattern goes through four stages of development and takes a long time to develop. Hence, not every part of the pattern is tradable. That being said, depending on your particular trading strategy, the portion of the pattern that is tradable can vary. 

With the Breakout Trading Strategy, it is advisable to enter a trade only after the construction of the handle is complete. Until then, you can never be sure that the chart pattern that you are looking at will materialize into a Cup and Handle Pattern, and thus the accuracy of your trades can be relatively low. 

Additionally, there are several other chart patterns, such as the Rounding Bottom Pattern, that look similar to the Cup and Handle Pattern, but would require a very different trading approach. 

Hence, for Breakout Trading Strategy, you would wait for the pattern construction to finish, and target to capture the price wave that emerges on the breakout from the handle.  

Determining Trade Entry

With the Breakout Trading Strategy, your goal is to enter a trade when the price breaks out of the handle. Additionally, when trading a Regular Cup and Handle Pattern, irrespective of the direction of the prevalent trend, you would always look for a bullish or a long trading opportunity post the breakout.

To identify a price breakout past the handle, listed below are two popular techniques that you can leverage – 

  • Trendlines: When the handle is in development, you can connect the highs of consecutive candlestick using a trendline and use it as the line of resistance. Any price break past this trendline will be seen as a breakout and signal you to look for a bullish trade entry.
  • Envelope/Channel Indicators: Similar to the use of trendlines described above, you can also leverage various Envelope or Channel Indicators to identify the resistance line for the handle. Any price break past the upper band of these indicators will be treated as a breakout and signal you to look for bullish trade entries. Examples of various Envelope/Channel Indicators that you can leverage for this purpose include the Bollinger Bands, the Keltner Channels, the Donchian Channels, etc. 

Additionally, you must remember that even if the price does pull through to form a Cup and Handle Pattern, the resulting bullish breakout that you expect in this strategy may never occur. The price may just continue to move sideways, or it could decline. Therefore, it is critical that you look for a few bullish confirmation signals before entering these breakout trades. 

Listed below are the two popular confirmation tools (as also described in previous sections) that can be leveraged to improve the accuracy of Breakout Trades using the Cup and Handle Pattern – 

  • Candlestick Patterns: Once the resistance line is broken, you can wait for a Continuation Candlestick Pattern to appear on the price chart before entering a long trade. By doing so, you can be sure that the newly emerged uptrend is there to stay and thereby minimize the risk of entering an unprofitable trade in the event of a False Breakout. 
  • Momentum Indicators: Momentum Indicators can provide confirmation signals to your breakout trade entries in two ways. First, and most importantly, you should check for bullish divergence on the price chart using these indicators before entering a bullish breakout trade. The presence of bullish divergence is considered a pretty reliable signal for the emergence of an uptrend. Additionally, you can also look for the momentum readings produced by these indicators and leverage them as confirmation signs.

Finally, before concluding this section, there is one additional tip that I would like to share. Typically, the time it takes for the construction of a handle to complete is less than that needed for the construction of the Cup. Therefore, if you don’t see a breakout past handle for a duration that is longer than it took for the construction of Cup to finish, you can assume that the pattern has failed to breakout and move on to look for other trading opportunities. 

Determining Stop Loss Level

Even though the Breakout Trading Strategy is counted among the most reliable trading strategies out there, False Breakouts are not very uncommon. Therefore, it is critical that you manage your risk appropriately with a Stop Loss. This will protect you against heavy and/or intolerable losses should the market move against your position.  

In principle, determining stop losses when trading the Cup and Handle Pattern using the Breakout Trading Strategy is fairly simple and can be summarized as follows –

  • You would put your stop loss just a few points below the resistance line on the break of which the trade was entered. If the price reverts below the resistance line, it signals that the breakout trade that you entered is no longer valid. Hence, you should consider exiting your position at this stage to minimize losses, and a stop-loss order will allow you to do that.  

That being said, if you want to trade more aggressively, there is another price level that you can consider placing your stop loss at. 

Structurally, during the construction of the Cup and Handle Pattern, the Handle must occur within the upper half of the Cup regardless of the Cup’s shape. Therefore, you can find the price level that is halfway between the highest and the lowest point of the Cup and set this price point as your Stop Loss. 

When not placing the Stop Loss immediately below the resistance line, you should avoid setting it higher than this mid-point level. This is because before the price trend gives a clear indication of its future direction, it may bounce back and forth a few times. Hence, even though you would not want to stop the trade too early, setting your stop loss above this mid-point level may lead you to do so.

Determining Take Profit Level

Just like setting Stop Loss Levels, determining Take Profit targets when trading the Cup and Handle Pattern with the Breakout Trading Strategy is relatively simple and objective. Below is how you can determine the trade profit targets for your breakout trades – 

  • First, measure the distance between the breakout point and the turning point of the curve (the bottom of the Cup and Handle Pattern). Then take the value of that distance and add it to the price value at the breakout point. The resulting price point that you get post this addition can be set as the Take Profit Level for your trade. 

Even though the methodology for setting the Take Profit Levels for Cup and Handle Pattern Breakout Trades described above is quite effective, you can always calculate these price targets using alternate methods in technical analysis. In addition to the above-stated strategy, I have personally found the Fibonacci Retracement and Extension levels and Pivot Points to be quite reliable in helping determine the take profit targets for such breakout trades.     

Advantages and Limitations of Trading with the Cup and Handle Pattern

The Cup and Handle Pattern is beyond doubt one of the most reliable chart patterns out there, but it does have its own set of strengths and weaknesses. 

When making trading decisions based on this pattern, it is important that you factor these strengths and weaknesses in your decision making. Therefore, in the following section, we will cover some of the most critical advantages and limitations of trading with the Cup and Handle Pattern.     

Advantages of Trading the Cup and Handle Pattern

Listed below are some of the most important advantages of trading the Cup and Handle Pattern – 

  1. It can be used in a variety of markets. For example –  stocks, Forex, cryptocurrencies, etc.
  2. It defines a relatively clear and objective trade entry, stop-loss, and take-profit levels for traders.
  3. For experienced traders, it is easy to identify and incorporate this pattern into a trading strategy.

Limitations of Trading the Cup and Handle Pattern

Listed below are some of the most important limitations of trading the Cup and Handle Pattern – 

  1. It does not occur within a specific time range. The pattern could develop in days, weeks, or months, and there are no specific guidelines on how much time it would take for this pattern to develop.
  2. There can be false signals or “False Cups and Handles” that give misleading information to traders.
  3. It does not guarantee that after the Handle, there will be a definite uptrend even though the pattern in principle prompts you to anticipate that.
  4. It is not an easy to identify pattern for novice traders.

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Conclusion 

To conclude, the Cup and Handle is a popular chart pattern that is heavily used by technical traders as an indicator of future price trends. It can be used in a variety of asset markets to indicate the direction the market is headed in, and always signals an upcoming bullish momentum in price trend. 

With a Regular Cup and Handle Chart Pattern, traders look for specific characteristics on the price chart that directionally imply that the price will recover from its downtrend or flat trajectory during the construction of the handle, and continue on the uptrend steadily. These characteristics that traders look for include the following – 

  • The Cup portion of the chart pattern is U-shaped and shallow relative to the price trend that preceded it. 
  • The Handle should have a slope that leads to almost horizontal movement and not one that downtrends below one-third of the distance between the breakout point and the bottom of the cup. 

When trading this pattern, it is essential that you allow for the Cup and Handle Pattern’s construction to complete before trying to make any trades using it. If you do not do this, you stand the risk of having made an inaccurate call that could cost you a lot of money when the trade goes against you. 

Overall, Cup and Handle Chart Patterns are useful and effective in identifying reliable bullish trades when traded using proven trading strategies. However, just as with any other chart pattern, do not make a trading decision that is solely based on this pattern. Combine your use of the Cup and Handle Pattern with trading signals from other complementary tools in technical analysis for making your trade decisions even more reliable. 

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    Navdeep Singh

    Navdeep has been an avid trader/investor for the last 10 years and loves to share what he has learned about trading and investments here on TradeVeda. When not managing his personal portfolio or writing for TradeVeda, Navdeep loves to go outdoors on long hikes.

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