Table of Content

Cup and Handle Pattern in Technical Analysis for Traders

An article including the definition, formation, and trading tips for the Cup and Handle pattern

 Hello Valued Traders,

We all know that imagining trading in financial markets without technical analysis is impossible. Chart patterns in technical analysis, however, are an important guidepost for deciphering the market's main arteries, which are trends. Chart formations reveal specific patterns and trends of past price movements. This provides us with clues to predict future price movements. The "Cup and Handle" formation, one of these patterns, presents an opportunity for profitable buying in uptrends. Now, I will discuss the definition, formation process, and trading strategy of the Cup and Handle pattern.

What is the Cup and Handle Pattern?

The Cup and Handle is a chart pattern observed in uptrends, indicating the continuation of the trend. This pattern identifies price movements in the upward trend, allowing for a more informed approach to buying decisions. The Cup and Handle pattern can provide a strong continuation signal when observed on long-term charts. Therefore, the Cup and Handle is a continuation pattern used in technical analysis. When it appears on the price chart, it is considered a sign that the uptrend may continue.

Illustration of Cup and Handle Chart Pattern
Cup and Handle Chart Pattern

Definition and Formation of Cup and Handle Pattern

The Cup and Handle pattern consists of two main parts, the "cup" and the "handle". This pattern can be defined as follows:

Cup: Firstly, an uptrend is observed where prices move downward. Then, prices usually consolidate for a while, forming the bottom of the cup during this period. Subsequently, prices slowly rise from the bottom, forming the other side of the cup. At this point, a U-shaped cup formation is completed on the price chart.

Handle: After the formation of the "cup" shape, prices encounter a resistance level at the mouth of the cup. As a result, prices generally retract slightly, but not as much as before. This retracement is short-lived, and prices still rise to the mouth level of the cup, forming a "handle". The handle is typically a shorter-term correction movement, indicating a point where prices are likely to resume their upward trend.

The retracement during the formation process of the pattern may occur due to the market experiencing a short-term correction. This correction can be influenced by various factors such as traders wanting to collect profits, observing market fluctuations, or waiting for more favorable price levels for new purchases. Once the Cup and Handle formation is completed, it is forecasted that prices will continue their current uptrend and reach higher levels.

Trading with the Cup and Handle Pattern

Using the Cup and Handle pattern, we can develop trading strategies. Now that we know this pattern signifies a continuation of price uptrend, it can create excellent opportunities for long positions. The buying process occurs when price movements in the handle area break a resistance level. This breakout is supported by traders resuming buying, and prices may continue to rise. Of course, volume analysis is an important factor to confirm the validity of the formation before opening long positions. Especially observing an increase in volume at the time of the breakout can enhance the reliability of the formation. However, it's necessary to consider other technical analysis tools and indicators (moving averages, MACD, MFI, RSI, etc.) to confirm the signal.

Entry Levels:

Two methods are preferred for buy orders:

1. On the neckline: As an entry level, it is possible to determine the buy order immediately after the breakout of the resistance level on the neckline or after the completion of the handle formation.

2. After the pullback: After the breakout of the resistance on the neckline, the price may pull back and test the broken level. If prices start to rise after the pullback, buying can be initiated.

Stop-Loss Levels:

You can choose between the two options based on your preference. These levels will help you protect your position against unexpected price movements.

1. Stop Loss levels are usually placed below the levels in the handle zone.

2. If buying is done after the pullback, the level tested by the price during the pullback can be used as the stop loss level.

Target Levels:

To determine the take-profit target, first measure the depth from the mouth to the bottom of the cup. Then, add this depth to the level where the breakout occurred to set the initial target price. This method is the most commonly used approach. In addition, Fibonacci retracement levels or subsequent resistance levels are also frequently used to determine target prices.

You can take a look at an example of a trade made using the Cup and Handle formation on the daily chart of the US Dollar Index below:

Illustration of Cup and Handle trade setup on daily chart of USD Index
Cup and Handle Trade Example on USD Index

Oh, Don't Forget! In financial trading, chart patterns are technical analysis tools that can provide positive signals. However, just like other chart formations, the "Cup and Handle" pattern may not always provide accurate signals and cannot guarantee the desired outcome. Contrary situations can also be encountered in trades aimed at profit in the Forex market. Therefore, this formation should not be used alone and should be evaluated together with other technical analysis tools.

Post a Comment