The Cup and Handle pattern is a bullish continuation pattern that was first identified by William O'Neil and introduced in his bestselling book, How to Make Money in Stocks: A Winning System in Good Times and Bad, which is currently in its fourth edition. Interestingly, this pattern appears on line, bar and candlestick charts, as well as Point-and-Figure charts. It is a long-term pattern and more suited to longer time-frames, such as the daily and weekly charts. It is rarely seen on shorter, intra-day charts.
The Cup and Handle pattern appears in an uptrend and consists of two parts: the cup and the handle:
- The Cup is formed when a series of gentle declines in prices interrupts the uptrend and is followed by an advance to more or less that same level that was reached prior to the decline. This may take the shape of a bowl or a rounding bottom but should not be a V-shape as it should form a consolidation area or a significant support area. Ideally, this decline should retrace about one third (33.3%) of the previous advance and no more than two thirds (66.6%) of the advance.
- The Handle is a trading range or a consolidation area that develops after the Cup is completed. This may be a bullish flag or pennant pattern, or a short pullback. Ideally, the handle should retrace no more than a third (33.3%) into the cup's depth. The shorter the retracement in terms of both time and distance, the more bullish the pattern.
The pattern is completed when the price action breaks the resistance level formed by the peaks that form the rim of the Cup.
The Cup and Handle pattern gives a long entry signal, i.e., a buy, when the price breaks above the resistance formed at the top of the cup. As with any situation where support or resistance is broken, the break out should ideally be accompanied by a significant increase in volume. If the volume does not increase, the probability of a false break out increases. Fortunately, the price should not move into the lower third of the cup, which makes it a good level to place a protective stop.
The price projection for the cup and handle pattern can be calculated by measuring the depth of the cup, i.e., from the peaks at the top of the cup to the bottom of the cup. This depth can then be added to the breakout point to find the projected price that should be reached as a minimum price target for this pattern.