Profitable Cup and Handle Trading Strategy
The profitable Cup and Handle trading strategy might be a humorous name. But the cup and handle pattern has a long history and was discovered by the famous trader, William J. O’Neil. He founded the stock brokerage firm, William O’Neil & Co. Inc.
If you want to become a cup and handle trader, you can either read William O’Neil's book, “How to make money in stocks.” Or you can simply read the full version of the cup and handle trading strategy by reading this article.
Our team at Trading Strategy Guides is working hard to develop the most comprehensive guide on different chart pattern strategies. In order to understand the psychology of a chart pattern, please start here, Chart Pattern Trading Strategy step-by-step Guide.
As the name suggests, the cup and handle pattern has a similar appearance to a teacup with a handle.
At TSG, we believe the Cup and Handle is one of the most authentic continuation patterns. Unlike the bullish flag pattern, which is a continuation pattern, the Cup and Handle pattern takes a lot of time to develop. This is why it’s such a reliable pattern.
Let’s get a little bit deeper into what Cup and Handle is, and how to make money trading with the profitable cup and handle trading strategy. You can also read the simple yet profitable strategy.
What is Cup and Handle?
The cup and handle pattern is a bullish continuation pattern. Now, this pattern typically has a run-up on the left side. You’ll see an uptrend that stops and forms a peak. Then it’s followed by a retracement back down, creating a cup-like bottom, or a rounded bottom.
So, the first Cup and Handle rule is that you need to have a previous trend. You need this in order to have a continuation pattern.
The bottom of the cup and handle pattern will dip about 15% to 50% from the peak.
The handle portion is a retracement downwards from the right side of the cup.
It’s important to remember that the handle section of a Cup and Handle pattern should resemble a very narrow price range. It can be contained inside two parallel lines, or it can take the shape of a smaller rounded bottom.
Normally, the handle of a tea cup can take many shapes. This can be the same when reading the price action for the Cup and Handle formation.
Basically, we can sum up the Cup and Handle pattern into three key components:
- Previous bullish trend.
- The Cup.
- And the Handle.
In the figure below, we have highlighted a real Cup and Handle pattern.
Note* Make sure the cup is a rounded retracement and the price progresses gradually through the retracement.
Now that we learned what a Cup and Handle pattern is, it’s time to look beyond the price action. Then understand the psychology behind this profitable trading pattern.
The Psychology behind Cup and Handle Pattern
Each of the two key components, the cup and the handle, triggers specific crowd behavior.
The cup component forms as a result of the buying power drying out. It doesn’t necessarily mean that sellers are stepping in either, or even if they do they lack the power to change the trend.
The rounded bottom really shows the buyers are in control and thus new highs should be expected.
The real trap comes from the handle component. This gradual and slow range is what will set the stage for the bullish trend to resume. People will think this is a double top which will trap some weak sellers when we finally break upwards.
Now, let’s see how you can effectively trade with the Cup and Handle trading strategy and how to make some profits.
Cup and Handle Trading Strategy
Now that we know what is Cup and Handle, let’s walk through the trading rules of the Cup and Handle trading strategy that can set you apart from the rest of the crowd.
Obviously, the Cup and Handle pattern can produce the best profits on the daily time frame. The pattern can be traded on the lower time frames as well.
Step #1: Identify and uptrend and a rounded retracement into that uptrend (The Cup)
We’re breaking down the Cup and Handle trading strategy into several steps. The first step is to identify an uptrend and a rounded retracement into that bullish trend. That rounded bottom is the first component of the Cup and Handle pattern.
The strength and the longevity of the prevailing trend is important as it will determine the success of the trade. How deep the rounded bottom goes will also influence our potential profit.
So far, so good.
Now we move to the second component of the Cup and Handle pattern and the second step of the Cup and Handle trading strategy.
Step #2: Draw the second component of the Cup and Handle pattern – The Handle
You can start drawing the handle once the cup component is finished.
Now, the cup component doesn’t necessarily need to end exactly at the same price where it started, but it needs to be near that price zone, or price target. Once you see the price moving away from the cup in a tight range you can start looking to draw the handle.
Next, we need to figure out an entry technique, which brings us to the next step of the Cup and Handle trading strategy.
Step #3: Entry 1 at the Handle breakout and Entry 2 at the first Cup peak breakout
We’re going to implement an unorthodox entry method and split our trade into two trades as follows:
- First buy entry on the Handle breakout, the upper line (resistance) that defines the Handle structure is our trigger line of the first buy order.
- Second buy entry on the breakout of the initial peak from where we started drawing the cup.
The next logical thing we need to establish for the Cup and Handle trading strategy is where to take profits.
Step #4: Take Profit equals the same distance in price as measured from the initial Cup peak to the bottom of the cup
The ideal profit target for the Cup and Handle trading strategy would be equal to the same distance in price as measured from the initial Cup peak to the bottom of the Cup.
The Cup and Handle pattern target maximizes the potential profit and it gives us the chance to capture the entire trend.
You are simply projecting the same distance in price to the upside using as a starting point the initial Cup peak.
The next important thing we need to establish is where to place your protective stop loss.
Step #5: Place initial SL below the rounded bottom. After the second entry is triggered move both SL below the Handle swing low.
Since we’re splitting our trade into two trades, we’re going to have two protective stop loss. The initial stop loss is placed just below the round bottom.
Since at this stage the Cup and Handle pattern is not yet confirmed we need to give it more space, that’s why we’ve chosen to place the SL below the round bottom.
One we enter our second buy order we can now safely move the SL for both positions below the Handle swing low.
Note*** The above was an example of a BUY trade… Use the same rules – but in reverse – for a SELL trade, but this time we’re going to use the inverted Cup and Handle pattern. In the figure below, you can see an actual SELL trade example, using the Cup and Handle pattern.
Once you learn what is Cup and Handle pattern you have no more excuses not to have a chance to succeed in trading. In the technical analysis field, the Cup and Handle pattern is one of the most profitable chart patterns. The Cup and Handle trading strategy is providing you with an effective way to exploit this pattern. You can also read about Trader Profile Quiz.
We always recommend you to backtest first the pattern and trade it a few times on a demo until you’re comfortable and have a good understanding of what is Cup and Handle pattern.
We hope that the Cup and Handle pattern examples provided throughout this article will improve your ability to spot this powerful pattern when trading real funds.
Make sure you also don't miss our amazing Triple Top Chart Pattern Trading Strategy which is the ultimate reversal trading strategy that you can have in your trading arsenal.
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