When the price of an item moves in a pattern that resembles a common shape, such as a triangle, rectangle, head and shoulders, or in this case a cup and handle chart patterns appear. These patterns serve as a visual representation of trading. They provide a sensible entry point, a risk-management stop-loss placement, and an exit price goal for profitable trades.
Learn how to trade the cup and handle chart patterns, as well as what to look out for to increase your chances of making a profit.
Small-time frames, such as a one-minute chart, and big-time frames, such as daily, weekly, and monthly charts, all exhibit the cup and handle pattern. When there is a downward price wave followed by a period of stabilisation, this happens.
After that, prices rise to around the same level as they were before the drop. It forms a U-shape, or the “cup” in a cup and handles pattern. The handle is formed when the price travels sideways or downward within a channel. A triangle-shaped handle is also possible.
The cup should be smaller than the handle. It should not fall into the bottom half of the cup, and it should ideally remain in the top third. If the cup is between $99 and $100, the handle should be between $100 and $99.50, preferably between $100 and $99.65. You should avoid trading the pattern if the handle sinks too far and erases the majority of the cup’s gains.
A cup and handle chart can indicate if a trend is reversing or continuing. When a price is in a long-term downtrend, a reversal pattern appears. The price then begins to rise as it forms a cup and handles pattern, reversing the trend. During an uptrend, a continuation pattern arises when the price rises, forms a cup and handle, and then rises again.
How to trade the Cup and Handle Chart Pattern?
Allow for the development of a handle. A sideways or descending channel, or a triangle, is commonly used as the handle. When the price rises above the top or triangle of the channel, you should buy. The pattern is deemed complete when the price goes out of the handle, and the price is projected to rise.
While it is expected that the price would grow, this does not guarantee that it will. The price may rise somewhat before falling; it may move sideways or fall immediately after entry. As a result, a stop-loss is required.
Putting a Stop-Loss Order
After buying a breakout from the cup and handling the price pattern, a trader can use a stop-loss order to pull out of a trade if the price sinks instead of climbing. The stop-loss limits the trade’s risk by selling it if the price falls far enough to invalidate the pattern.
Set a stop-loss order below the handle’s lowest position. A stop-loss could be placed below the most recent swing low if the price oscillated up and down many times within the handle.
A properly positioned stop-loss should not end up in the lower half of the cup formation since the handle must occur within the upper half of the cup. Consider a cup that forms between $50 and $49.50. Because this is the halfway point of the cup, the stop-loss should be over $49.75.
The handle and stop-loss are placed in the upper third (or upper half) of the cup, which keeps the stop-loss closer to the entry point and improves the risk-reward ratio of the transaction. The risk element of the trade is represented by the stop-loss, while the profit portion is represented by the target.
Choosing a Profitable Exit or a Target
Trading with the Cup and handle pattern includes exiting at the correct moment. Calculate the height of the cup by multiplying it by the handle’s breakout point. The goal is to reach that number. The aim is $101 if the cup forms between $100 and $99 and the breakout point are $100. The left side of the cup is occasionally taller than the right. For a conservative target, use the smaller height and add it to the breakout point. You may also use the increased height to create a more aggressive target.
If you’re day trading and you don’t reach your aim before the end of the day, close the position before the market closes. If the cup and handle form following a downtrend, it may indicate a trend reversal. Look for the downside price waves to get smaller as they approach the cup and handle to increase the chances of the pattern concluding in a true reversal. The smaller down waves into the cup and handle indicate that selling is slowing, increasing the chances of an upside move if the price breaks through the handle.
Trading the Cup and Handle pattern is an essential step in the journey of every trader. Through FinLearn Academy’s course on ‘Ways to Trade the Cup and Handle pattern’ one can become a better trader in the stock market.