The cup and handle pattern was first identified by entrepreneur and stockbroker William J. O’Neil and explained in his 1988 book “How to Make Money in Stocks.” The bullish chart pattern is easy to find using basic technical analysis on exchange rate charts.
The cup and handle pattern generally forms as a consolidation phase seen after an upward move, and it suggests that the previous rising trend will subsequently continue. It is considered a reliable bullish continuation pattern because it indicates a potential continuation of an upward trend, although the cup and handle pattern is not foolproof.
Forex traders using the cup and handle pattern should always use proper risk-management techniques, such as setting stop-loss orders and managing position sizes to minimize any potential losses. Read on for more information about how to identify and trade this useful chart pattern.
What is a Cup and Handle Pattern?
A cup and handle pattern is a technical analysis pattern appearing on exchange rate charts that is formed by a cup-shaped curve followed by a small consolidation period or trading range that forms the handle. A breakout is then confirmed by a rise in trade volume.
The cup and handle pattern is a bullish chart pattern that can be used by traders to identify potential buying opportunities in the forex market. The pattern typically forms after a sustained uptrend, and it is characterized by a rounded bottom (the cup) followed by a small consolidation (the handle).
The pattern signals that the market is taking a breather before resuming its upward momentum. The cup and handle pattern is considered a reliable indicator because it is often accompanied by high trading volume, which indicates that traders are actively buying the currency pair.
The cup and handle pattern is characterized by the following elements:
- Cup: The cup-shaped curve represents a gradual price increase over time.
- Handle: The handle represents a brief period of consolidation, where the price trades in a narrow range.
- Breakout: A breakout occurs when the price moves above the resistance level formed by the top of the cup and handle. This signals a strong buy signal.
- Volume: High trading volume is typically seen during the formation of the pattern, which further confirms the validity of the pattern.
The cup and handle pattern can be used by currency traders to identify potential buying opportunities in the forex market, although because the chart pattern is not always reliable, it should be used in conjunction with proper risk-management techniques and other technical analysis tools to confirm potential trading opportunities.
How to Identify the Cup and Handle Pattern in Forex Charts
The cup and handle pattern is a relatively new chart pattern but is increasingly being used by forex traders to suggest potential trading opportunities. Many use additional technical analysis tools — such as visual signs, trend lines, support and resistance levels, volume data and moving averages — to identify the cup and handle pattern on a forex chart. A step-by-step guide to identifying this pattern appears below.
Step 1: Find a U-shaped Chart Formation
The first step in identifying the cup and handle pattern is to look for a U-shaped formation on the exchange rate chart. This forms the cup part of the chart pattern.
Step 2: Look for a Following Handle
The second step comes after you observe the second high level of the cup part of the pattern that closely matches its first high level. You should then see a small downward or sideways movement in the exchange rate that forms the handle part of the chart pattern. The handle typically appears as a short-term exchange rate decline or consolidation after the second high of the cup, and it should be modestly sized relative to the cup’s size, often retracing less than one-third to half the cup’s depth.
Step 3: Check the Volume
Many traders also look at the trading volume during the formation of the potential cup and handle pattern to confirm it. Volume should remain high as the cup is forming, but it should gradually fall as the handle is formed. This indicates that buyers are losing interest and sellers are slowly gaining control over the market.
Step 4: Watch for the Breakout
After the handle formation nears completion, traders can watch for the pattern’s breakout that occurs once the exchange rate rises above the resistance level formed by the two highs at the start and end of the cup. This break signals that bullish sentiment is now strong enough to overcome selling pressure so the upward trend is likely to continue.
Step 5: Enter Trade
The breakout signals when to enter trade orders since the cup and handle pattern has been confirmed, and the upward trend is now likely to continue. Traders might take a long position at the market exchange rate soon after it exceeds the cup’s upper resistance level. They might simultaneously put their stop-loss order below the handle’s low point that now offers support. Profit objectives are usually obtained by measuring the height of the cup formation and projecting it upward from the pattern’s breakout point. A take-profit sell order can be placed at or just before that objective.
Cup and Handle Pattern Trading Example
As an example of how to trade a cup and handle pattern, consider the situation where a forex trader operating in the USD/JPY currency pair observes a U-shaped chart pattern with two highs at 135 and an intervening 130 low that is followed by a small downward or sideways consolidation phase that falls as low as 133.5. Their analysis noted that this pattern met all the visual criteria of a cup and handle pattern.
The trader then looks to confirm the pattern by checking the volume seen during its formation. They observe that the volume remained high during the cup formation phase and it then gradually decreased as the handle formed.
They then waited for the USD/JPY exchange rate to break out of the confirmed cup and handle pattern by breaking above the 135 level. Once that happens, they computed the width of the cup to be 135-130 = 5 and projected that amount upward from the 135 breakout level to yield a 140 profit-taking objective.
The trader then quickly enters a buy order at the post-breakout market level of 135.25, placing their stop-loss sell order at 133.25, just below the handle’s low point of 133.5. They also enter their take-profit order at 139.75, which lies just ahead of their 140 objectives.
The trader will now need to monitor their position until either their stop-loss or take-profit levels are reached and the trade is closed out. Traders can also consider scaling out of the trade as it moves in their favor.
If their take-profit level trades first, then they will make 139.75-135.25 = 4.5 or 450 pips, but if their stop-loss order level is triggered then they will lose 135.25-133.25 = 2 or 200 pips. Their risk/reward ratio on the trade is therefore 1 to 450/200 = 2.25.
Strategies for Trading the Cup and Handle Pattern
Forex traders can use the cup and handle pattern to identify potential trading opportunities and make profitable trades in the forex market. It's important to remember that trading always carries risk, and it's essential to have a solid risk-management strategy in place to protect your capital.
Entry Points and Stop-Loss Levels
The ideal trade entry point for a cup and handle pattern that has broken out is just above the breakout point, which would be 135 in the above example. The trade can be entered either with a market or limit buy order.
A stop-loss order to limit potential losses is also typically put into the market just below the lowest point of the handle of the Cup and Handle pattern, which was at 133.5 in the previous example. Take-profit sell levels are typically set near the pattern’s objective or just below a nearby resistance level.
Confirming the Pattern with Technical Indicators
Confirming the cup and handle pattern with technical indicators can help forex traders increase the probability of success in their resulting trades. Some of the most commonly used technical indicators for confirming this chart pattern include:
- Volume: Volume is a crucial indicator for confirming the cup and handle pattern. The pattern is generally characterized by high trading volume during the cup formation followed by a decrease in volume during the handle formation.
- Relative strength index (RSI): The RSI can be used to identify overbought and oversold conditions in the forex market. When the RSI lies in oversold territory with a reading below 30 while the handle forms and then moves above its 50 midpoint level as the cup and handle pattern breaks out, it can be seen as a confirming bullish signal.
- Moving averages: Moving averages computed of an exchange rate can be used to identify the direction of the market trend because a positive slope indicates an upward trend, while a negative slope reflects a downward trend. Traders can also use a combination of shorter-term and longer-term moving averages to confirm the cup and handle pattern’s breakout and provide a clear trading signal when the short-term moving average rises above the longer-term average.
- Fibonacci retracement and projection levels: These theoretical levels are computed from previous market moves. Traders can use them to identify potential support and resistance levels that can help traders identify possible points to enter and exit trades.
By using these technical indicators in conjunction with the cup and handle pattern, forex traders can both confirm the pattern and increase their chances of making profitable trades.
Position Sizing and Risk Management
Position sizing and risk-management strategies are critical components of any forex trading plan and allow traders to increase their chances of trading a cup and handle pattern profitably. Before entering a trade based on this pattern, you want to determine the appropriate position size based on your account balance, risk tolerance and the level of your stop-loss order.
As a place to start, you can calculate a suitable trade size by taking the dollar amount of risk you want to take on, multiplying it by the stop-loss exchange rate level and then dividing the result by the distance between your entry level and your stop-loss level.
In the above example, the trade entry level was 135.25, while the stop loss level was 133.25, so the difference is 2. If you want to take on $2,000 in risk when making this trade, then you can trade in a position size of ($2,000 x 133.25)/2 = $133,250.
Also, setting a stop loss is essential for limiting your potential losses just in case a cup and handle trade goes against you. Your stop loss should generally be placed below the low of the handle formation to minimize the risk of being stopped out prematurely.
To maximize your profits trading a cup and handle pattern, you can use a trailing stop-loss sell order that ratchets up as the exchange rate moves higher in your favor. You can also consider taking partial profits at predetermined levels based on your projected profit target for the pattern. This can help lock in profits and reduce the risk of losing all of your gains if the market suddenly reverses.
Because emotions can often lead to irrational decision-making, they are important to manage appropriately when trading the cup and handle pattern so they do not dictate your trading decisions and boost your trading risks to uncomfortable levels. Good practices to follow include sticking to your trading plan in a disciplined manner and avoiding emotionally driven errors like adding to losing positions, pulling stop-loss orders and trading excessively.
Common Mistakes to Avoid when Trading the Cup and Handle Pattern
While the cup and handle pattern is considered fairly reliable when generating trading signals, using it has potential pitfalls. Make sure to familiarize yourself with the following common mistakes so you can avoid them when trading this chart pattern.
Overreliance on the Pattern Without Confirming Signals
This is a common mistake made by some cup and handle pattern traders. The pattern should be viewed as just one tool in a trader's arsenal and should not be relied on solely for making trading decisions.
You can look for additional technical indicators and signals, such as those mentioned in the sections above, to confirm the pattern before entering a trade because a failure to do so may result in false signals and lead to losing trades.
Ignoring Market Conditions and News Events
Traders using the cup and handle pattern should remain cautious of sudden changes in market sentiment and conditions based on news events that could invalidate the pattern. The forex market is constantly evolving, and news events can have a significant impact on currency pair exchange rates.
Market conditions, such as prevailing levels of volatility and liquidity, can also play a critical role in trading the cup and handle pattern. Ignoring these factors to rely solely on technical analysis can result in false signals and losing trades.
Make sure to have a clear understanding of market conditions and stay informed of any news event, economic data release or other developments that could impact the currency pairs you are trading. It helps to keep a sharp eye on economic calendars and scheduled news releases so that you can stay well-informed about market events. This can help you make better trading decisions based on current market conditions.
Failing to Adjust the Trade Plan Based on New Developments
This is a common mistake some traders using the Cup and Handle pattern make. Forex market conditions can change quickly, so traders need to react nimbly and remain willing to adjust their trade plans as needed. Traders must also stay informed and keep an eye on the market, while also having contingency plans in place for unexpected developments that could impact their positions.
Traders sometimes encounter unexpected news events or sudden changes in market sentiment that require modifications to their cup and handle trade plan. Failing to adjust the plan can result in missed opportunities or increased risk.
Basically, traders using the cup and handle pattern must remain flexible and ready to adjust their trade plans based on new developments. This lets them adapt to changing market conditions and make informed trading decisions consistent with their risk-management goals.
Should You Use the Cup and Handle Pattern to Trade Forex?
The cup and handle pattern can be a useful tool for trading forex, but like any chart pattern, it should not be used as the sole basis for making trading decisions. Traders should generally use caution and carefully confirm the pattern with other technical indicators before entering a trade based on it.
When trading the cup and handle pattern, you also should consider present market conditions and stay aware of any news events that could impact the pattern's validity. You also should have a solid risk-management plan in place to help protect your account from potential losses in case the pattern fails.
Because no risk-based trading strategy can guarantee success in the forex market, you must be prepared to adapt your strategy based on changing market conditions. The cup and handle pattern can be a useful addition to your forex trading toolbox, but it is typically best used in conjunction with other technical analysis tools and prudent risk- and money-management practices.
Frequently Asked Questions
Is cup and handle a reversal pattern?
No, the cup and handle pattern is not a reversal pattern but is instead a bullish continuation pattern. It typically forms during an upward trend and signals a potential continuation of that bullish trend after a brief consolidation phase.
Is a cup and handle pattern bullish?
Yes, a cup and handle pattern is a bullish continuation pattern. Once confirmed, technical traders usually view the pattern as a signal to enter a long position or to add to an existing long position.
What does a cup and handle pattern indicate?
A cup and handle pattern is a bullish chart pattern that indicates a potential continuation of an uptrend after a brief consolidation period. The pattern is named for its resemblance to a cup with a handle.