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After a nasty 2022 bear market, the Nasdaq has made a bullish advance back above its 50-day moving average.
As conditions continue improving, astute swing traders who target emerging, bullish chart patterns may be highly rewarded.
The cup and handle is one such bullish chart pattern that may soon start appearing in the coming weeks and months.
Are you prepared? Do you know how to spot the cup and handle and exactly when to buy it?
If not, we’ve got you covered right here.
Continue reading to discover 10 simple steps to identify a proper cup and handle pattern and the proper time to buy.
What is a Cup and Handle Pattern?
The cup and handle is a bullish continuation pattern that forms when a stock or crypto falls, forms a sideways base, then rallies back to the previous high.
The “cup” part of the pattern is the round, downward-sloping portion of the chart that develops after the price pulls back and forms a base.
The “handle” is the relatively flat part of the pattern that forms after the price has rallied back to the prior high and consolidates.
Completion of the cup and handle pattern occurs after the price breaks out above the high of the handle and zooms higher.
Formation of the bullish pattern resembles a tea cup; hence the name “cup and handle.”
The cup and handle is one of the most well-known types of base breakouts among swing traders—but don’t be fooled!
Not every chart that looks like this is a PROPER cup and handle pattern.
But don’t worry, we’ve created an easy 10-step checklist to help you identify a valid cup and handle. Check it out below.
10 Simple Steps to Identify a Proper Cup and Handle Pattern
If you think you may have spotted a cup and handle chart pattern, use the 10-step checklist below to make sure the pattern is valid.
See the annotated chart above as you review the 10 steps below:
- Near the high is best – The best cup and handle patterns develop within an existing uptrend and with the price near 52-week highs. Near the 52-week high is ideal, but #2 below is also okay.
- At least 30-40% off the low – If the stock or crypto is not already in a strong uptrend near its high, then the price should be at least 30-40% above the 52-week low BEFORE the cup develops.
- Moving average confirmation – The 50-day moving average should be above the 200-day moving average, and both moving averages should be trending higher.
- Base criteria – The base (bottom of the cup) should form on a pullback of 20-35% below the prior high. The base should also be at least 7 weeks in length.
- Rounded cup – The cup formation should have a rounded look, rather than a V-shape.
- Pullback not too steep – If in an uptrend, the bottom of the cup should be no more than 35% below the high. Cups that are 40-49% deep is too wide, which creates too much overhead price resistance.
- Light volume – Volume should dry up at some point near the bottom of the base of the cup. This indicates the sellers are gone and enables the bulls to resume control.
- Proper handle length – The ideal length of the handle is 3 to 4 weeks. At a minimum, the handle should be at least 5 days long. The handle should also be less than two-thirds the length of the cup below it.
- Proper handle depth – Handles typically slope lower, but the low of the handle should not be more than 12% below the handle high. More than 15% below the high is too deep, and increases the odds of pattern failure.
- Mid-point maximum – The mid-point of the handle should be above the mid-point of the base. Most of the handle should be above the 50-day moving average.
How to Properly Trade the Cup and Handle Pattern
When a cup and handle pattern follows through, it typically generates gains of +20% to 30% over several weeks (see above).
But merely identifying the cup and handle chart pattern is not enough to profit. Rather, you must also know exactly when to buy for ideal, low-risk entry points.
When to Buy for a Low-Risk Entry Point
The traditional buy point is a breakout above the high of the handle, which clearly puts bullish momentum on your side.
However, many swing traders prefer earlier entry points before the actual breakout above the handle.
- Buying a breakout above the short-term downtrend line (from the high of the handle)
- Buying a low-volume pullback to support of the 20-day moving average (within the handle)
If seeking an early point, then be sure to enter with partial share size to minimize risk.
Then, you can add the rest of your position size after receiving confirmation of the handle breakout.
Don’t Forget Your Stop
Proper technical analysis puts the odds of winning in your favor, but you must always be prepared to cut your loss if the pattern fails.
With a typical breakout entry above the handle high, your stop loss should be not more than 7% to 10% below your entry price.
Early entries can benefit from tighter stops, such as several percent below the downtrend line or 20-day moving average (depending on the basis of your entry).
With a typical profit target of 20% to 30% for a cup and handle breakout, a maximum stop of 10% still gives you a positive risk-reward ratio of 1:2 to 1:3.
The cup and handle is a reliable chart pattern of technical analysis that can quickly lead to great gains.
When you come across a potential cup and handle pattern, use the simple 10-step checklist above to make sure a valid chart pattern has formed.
After verifying the pattern, set a buy stop for potential entry above the high of the handle. Early entries can provide you with a lower buy price, but limit your purchase to partial share size for proper risk management.
Of course, keep in mind that the cup and handle pattern can fail, so always use stops. Don’t risk more than 7% to 10% below your entry price, and even less with an early entry point.
Continually scanning hundreds of charts to detect this pattern is challenging, but we’re already doing the hard work for you.
Do you trade the “cup and handle” pattern? What other criteria do you look for? Drop us your comments below.
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