Cup and handle pattern

The cup and handle pattern is a trading pattern that can be analysed in all financial markets. The cup and handle formation is created when the price of an asset falls but then makes its way back up to the point where the fall started. Cup and handle patterns are found on all timeframes, from intraday charts up to weekly and monthly charts.

The theory behind the cup and handle pattern is that if the price tried to drop but then rebounded, there must be strong buying momentum behind the asset to continue moving higher. This could attract traders to open a position at the price rise, or at least avoid opening a short position against it. This article will explore how to identify and trade the cup and handle pattern in various financial markets.

How to identify a cup and handle pattern

A cup and handle pattern is formed when there is a price rise followed by a fall. The price rallies back to the point where the fall started, which creates a “U” or cup shape. The price then forms the handle, which is a small trading range that should be less than one third of the size of the cup. It can be horizontal or angled down, or it may also take the form of a wedge or triangle.

When the pattern is complete, a long trade could be taken when the price breaks above the handle. However, some traders make the mistake of assuming that once a U-shape forms, the price will drop to form a handle. It may not, so you should ideally avoid trading the pattern until it has fully formed, in order to confirm the trend. You could wait for the price to break above the handle to signal that the uptrend is continuing. This is called a bullish continuation pattern.

Above is an example of two cup and handles that formed in the Big Tech share basket on our Next Generation trading platform. The pattern on the left is more complex as the cup pattern is wavy and harder to identify. The pattern on the right is more traditional, with a clear cup (or V, in this case) shape, followed by a handle breakout to the upside.

Cup and handle patterns: bullish or bearish?

A cup and handle is typically considered a bullish continuation pattern. That said, it matters more how the price moves after the cup and handle has formed that determines whether the price action is likely to continue being bullish or moving in a higher direction. Once a cup and handle pattern forms, in order to generate a bullish trade signal, the price must break above the top of the handle that has formed.

A drop below the handle is not necessarily bearish. The price may drop slightly, then rally back up, forming another handle or breaking above the initial handle. There is also an upside-down cup and handle pattern, called the inverted or reverse cup and handle. This is a bearish pattern and it looks different to the traditional cup and handle.

Cup and handle trading patterns

The cup and handle pattern can take on several variations in appearance. For example, a cup is not always a smooth “U” shape. It may be wavy, making small swings up and down as it forms the overall cup shape. The price may also rise and fall sharply, forming a “V” shape. The following gold monthly chart shows both a V-shaped cup and handle, as well as a large U-shaped cup and handle that is potentially forming. The latter pattern is not confirmed yet since a handle has not formed.

There is also variation in how the handles form. As mentioned, we may see triangles, or we may also see trading ranges or channels. Below is an example of a EUR/USD cup and handle daily chart, where the handle represents a channel or trading range angled down.

Cup and handle patterns in forex

Cup and handle patterns are also traded in the forex market, especially by day traders. When using a day trading platform, cup and handles tend to perform better during active times of a specific currency pair. When the forex markets are not open, the pair tends to be quieter, which means less movement, and it also means that intraday cup and handle patterns will not form as strongly. This is because there is not sufficient momentum to fuel a breakout and bullish trend.

For swing traders, trading on four-hour, daily, weekly, or monthly charts, cups and handles are traded in the same way as discussed throughout the article.

Cup and handle patterns in stocks

Shares and stock indices with lots of upward momentum prior to the cup and handle forming tend to produce the most favourable cup and handle patterns for trading. If a stock or index is strongly rallying prior to the cup and handle forming, there is a high chance that many buyers are already interested in the stock and will step in to fuel the price higher once the cup and handle forms. In this case, traders may focus on stocks or indexes that saw strong percentage advances heading into the cup and handle pattern.

The Big Tech share basket chart provides an example of this. Prior to the decline that started the cup and handle pattern, the price had advanced about 30% over several months. The upward momentum carried through following the cup and handle.

Read more about stock chart patterns here.

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Inverted/reverse cup and handle patterns

The reverse cup and handle pattern is an upside-down cup followed by a handle and a breakout to the downside. It represents a bearish continuation pattern. The pattern is formed by a drop, a rally, then another drop back to where the rally started. A handle forms, which should be less than a third the size of the cup.

When the price breaks below the handle, it signals traders to exit long positions or enter a short position. A stop-loss order is then placed above the handle and a profit target is calculated by the height of the cup subtracted from the handle breakout point. Alternatively, traders could double the size of the handle and subtract that from the handle breakout point.

Below is an example of an inverted cup and handle on the FTSE 100 weekly chart. Although the pattern formed and the price did decline, ultimately, the price did not follow through to the downside.

How to trade cup and handle patterns

The cup and handle pattern can be seen almost as a trading strategy, as the pattern provides an entry on the handle breakout, a stop-loss below the handle and a profit target based on double the handle size or the height of the cup. The pattern can be traded on all markets and timeframes. No technical pattern works all the time, which is why a stop-loss is used to control the risk on trades that are less efficient.

When studying price charts for trading patterns, our online trading platform, Next Generation, comes with a vast range of drawing tools that you can use to display your data more clearly. This includes drawing trendlines for the handles to highlight the breakout points, notes to mark important areas, or arrows to highlight potential entry and exit points. We also offer a chart scanner with pattern recognition software that works automatically to detect and highlight trends for your ease of trading.

Register for a live account now or practise first with virtual funds on our demo account to familiarise yourself with the platform.

Cup and handle stop-losses and profit targets

The entry point for a cup and handle pattern is to buy when the price moves above the handle formation. This is made simpler by using a drawing tool and waiting for the price to move up and out of the drawn handle pattern. A stop-loss can be placed below the low price point in the handle.

An estimated target is the height of the cup added to the handle breakout point; however, this may not always be met, as it requires a large price movement. A more conservative target is taking the height of the handle, multiplying it by two and adding it to the breakout price of the handle. This method provides a trade with a 2:1 risk/reward ratio. The potential profit is twice the risk because the risk is the size of the handle.

Above is a EUR/USD daily chart example with all the trade levels marked. The breakout point is 1.13. The channel height is 250 pips. Multiplied by two, that means a target is placed at 1.18, 500 (0.05) pips above 1.13. A stop-loss is placed one pip below the low price within the handle, which is 1.1168.

The other profit target is to take the difference between the bottom of the cup and top of the handle to calculate the height. In this case, it is 784 pips. Added to the 1.13 breakout point, the other target is 1.2084.

All the same concepts apply, regardless of whether the cup is “U” shaped, “V” shaped or wavy, or whether the handle is a triangle, wedge, or channel.

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