The cup and handle pattern is a bullish continuation pattern that marks a consolidation period followed by a breakout. It was developed in 1988 by William O’Neil.
As the name implies this pattern consists of two parts. The cup forms after an upwards trend when the price is consolidating with a rounded bottom. After the cup has been completed a trading range develops to the right of the cup to create the handle. After this handle a subsequent breakout above the handle signals a continuation of the trend before the cup started.
The below example is the EURJPY from last September is a classic cup and handle pattern with a smooth cup form with a handle retraces around 30% before the handle is broken. The break of the handle is tested several times pulling back to the resistance level followed by a powerful move upwards.
The depth of the cup can be used to give yourself a take profit level. The distance from the top lip to the bottom of the cup can be applied from the break point of the handle. The formation can create powerful moves and the ability to have a close stop loss back within the handle.
Trend – As this is a continuation pattern a trend must be in place before which in the above example is an upward trend coming into the cup. Unlike other continuations you do not want the original trend to be in place for a long period of time but a couple of month max.
Cup – This should resemble a cup or bowl and if it is too V shaped then it could be too sharp of a reversal to qualify. The softer the shape the higher the probability that this is a consolidation period and gives a higher percentage of the pattern completing. The perfect pattern would have two identical peaks to form the cup but this is not always the case.
Cup Depth – In a perfect pattern the cup depth would be about 1/3 of the initial trend. However, this is rarely an exact science and reach a retracement of ½ of the initial trend.
Handle – After the high on the right of the cup, you will see a pullback which helps to form the handle. The handle shape can vary, resembling a flag or pennant that slopes back downwards but other times it is just a quick short pullback. The handle represents the last consolidation before the breakout above the resistance line which can be up to 1/3 of the cups advance. The smaller the retracement of the handle the more bullish the formation. Many traders will wait until it has crossed the resistance line before the pattern is confirmed and you can go long.
Duration – This can vary substantially with the cup lasting for 1-6 months and the handle for 1-3 weeks.
Volume – You should see an increase in volume during the breakout after the handle
Target – The target price should be the same distance from the top right of the cup down to the bottom of the cup applied to the breakout point.
As with most trading patterns it is more important to capture the essence rather than the specifics. The ratios of the cup depth and handle do not need to be exact, but lead to the same general pattern with a consolidation period (cup) with a slight pullback after (handle).