Cup and Handle Pattern: Meaning, Benefits & Examples

The cup handle pattern is a type of bullish formation for forecasting the continuation of an upward price movement. Ideally, it appears amid an already existing uptrend. The formation indicates that the increase will continue even after it has been completed and confirmed. Understanding and effectively applying the cup-and-handle pattern can provide great support in predicting market trends and improving trading performance. This article will cover the cup-and-handle pattern, one of the most important chart formations that resembles a cup with a handle. We will also learn how to trade cup and handle pattern stocks, discuss various trading strategies associated with it, and mark the most important considerations for optimizing decisions and profit potential.  

How to Identify Cup and Handle Pattern

Here’s how you can identify a cup and handle patterns. 

Entry Point

• Handle for Shape Identification: Look at handles that have a lateral channel or triangle shape.
• Buy the Breakout: Buy on a break over the upper boundary of a channel or triangle.
• Be prepared for variations: Expect the price to move up but return to the same level shortly after you get out of the handle.
• Use Stop-Loss: Use a stop-loss to regulate the level of risk even with an expected change in prices. 

When to Use Stop-Loss

• Role of Stop-Loss: It is always imperative that a stop-loss be used to regulate the risk while trading.
• Stop Under Low of Handle: A stop-loss must always be placed under the lower low of the handle.
• Readjust for Reshuffle: If the price reshuffles in a handle, a stop-loss must always be readjusted just below the current swing low.
• Handle High: Place the stop-loss in such a way that the handle remains within the upper half of the cup and the stop-loss does not touch the bottom half.
• Low Stop-Loss Avoidance: Do not trade if the stop-loss happens to be below the middle of the cup.
• Best Position: All placements should be put at the upper third of the cup and handle pattern to obtain a good risk-reward ratio.

Exit Point Selection

• Calculate Target Price: Determine your target price by adding the height of the cup to the handle's breakout point.
• Example Calculation: If the cup and handle pattern ranges from ₹100 to ₹102, with a breakout at ₹102, set your target at ₹104.
• Consider Height Variations: Be aware that the left and right sides of the cup may have different heights.
• Set Conservative vs. Aggressive Targets: For a conservative target, use the lower height as your exit point. For a more aggressive target, set the exit point higher.
• Day Trading Strategy: If your target isn’t reached by the end of the trading day, close your position before the market closes.
• Use Trailing Stop-Loss: Consider a trailing stop-loss to exit a position that is nearing the target but starts to decline.

How to Trade in Cup and Handle Pattern

Entry and exit points for a cup and handle pattern and an inverted cup and handle pattern demand deep knowledge of technical analysis. While entry for both the patterns happens at the breakout point. 

• Entry Point: The entry point for both patterns happens at the breakout point.
• Stop-Loss: The stop-loss for both should be placed below the handle. For the inverted cup and handle, it should be placed at the high point of the handle.
• Target: Both patterns are designed such that their target must be at the opposite end of the cup range. For example, if the pattern assumes the form of an up trend and is formed between 90 and 100 for the cup then the corresponding target must be at about 110. If, however, the inverted cup and handle are formed between 100 and 90 then the target in a downtrend must be at about 80.

Example of Trading in Cup and Handle Pattern

In the above chart, you can find the cup and handle formation quite easily. Here, the current price of the stock is ₹250. You can enter the trade at the breakout point after the completion of the handle in the pattern, which is the neckline. In this case, the neckline is at ₹250. Hence, 

• Buy-In Zone: At or slightly above the neckline (e.g., ₹255)
• Stop Loss: Below the trough of the handle (e.g., ₹240)
• Target: Calculate based on the maximum drawdown during the cup formation. 

Now, the Maximum Drawdown is the difference between the highest and lowest points of the cup. So,  

Maximum drawdown = ₹300 - ₹200 = ₹100

Percentage drawdown = (₹100 / ₹300) * 100% = 33.33% 

In addition, you can find the target price by adding the percentage drawdown to the buy-in price. Thus, 

Target price = ₹255 + (33.33% of ₹255) = ₹339.99.

Selecting a Successful Exit

No matter the cup height, increase the handle's breakout point by that height. The optimal objective is that amount. For instance, if your breakout point is ₹100 and your cup size is between ₹100 and ₹99, your aim is ₹101. The heights of the cup's left and right sides can occasionally differ. For conservative objectives, add a lower height to the breakout point; for aggressive targets, use a greater height.  

Close your position before the market closes for the day if you are a day trader and do not hit your objective before the end of the day. A trade that has reached the objective but is beginning to fall again can also be sold using a trailing stop-loss.

Limitations of the Cup and Handle Pattern

There are both bearish cup and handle patterns and bullish cup and handle patterns. However, as with other technical indicators, the cup and handle chart pattern must be used in conjunction with other signals and indicators before trading. Traders have found some specific limitations with this pattern.  

• It takes quite a long time for the pattern to fully emerge, which may lead to delayed decisions. 
• Generally, the cup and handle pattern can develop on a period scale of one month to one year. However, it may develop within a much shorter period or indeed over several years. Therefore, it may be unclear.
• Another problem is the cup depth of the pattern. Sometimes, a shallower cup may indicate a false signal whereas a deeper cup might produce a false signal some other time. 
• Further, sometimes the cup fails to develop the traditional handle. 
• Finally, one drawback of most technical analysis patterns is their lack of reliability when used with thinly traded stocks.

Conclusion

The cup and handle pattern is a bullish continuation or reversal price structure frequently utilized to spot purchasing opportunities. Follow price changes on a chart and scan for the "u" shape and the downward handle to identify the cup and handle. You can identify a legitimate Cup and Handle pattern by following several guidelines about the underlying asset's length, depth, and liquidity. This pattern creates an "n" shape with an upward handle by moving opposite the cup and handle. Also, managing your Demat account is simple and safe when using a user-friendly platform like BlinkX. Investors may swiftly perform trades, and manage their holdings with the BlinkX trading app.