11# Cup and Handle (Continuation Pattern)
Cup With Handle is a rally to a new high, a decline of 20 -50 percent over 8 - 12 weeks, a rally falling just short of the new high level, a second decline of 8 - 20 percent over 1 - 4 weeks followed by a breakout to fresh new highs on strong volume.
The technical target for a cup with handle pattern is derived by adding the height of the "cup" portion of the pattern to the eventual breakout from the "handle" portion of the pattern.
• Cup with handle patterns are very similar to double top patterns with the exception being that selling does accelerate after the formation of the second top, instead the stock consolidates and eventually pushes beyond overhead resistance on strong volume.
• Generally, most cup with handle patterns are completed over the course of 9 -16 weeks and involve two separate pullbacks of 20 - 50 percent (cup portion) and 8 -20 percent (handle portion).
• Upside breakout from the handle portion of the pattern should occur on strong volume. This increase in volume verifies that selling pressures have been satiated.
• Upside breakouts often lead to small 2-3% rallies followed by an immediate test of the breakout level. If the stock closes below this level (now support) for any reason the pattern becomes invalid.
Like most technical patterns, the Cup With Handle pattern is really little more than a variation of another technical pattern. In this case that pattern is the Double Top. The pattern begins after a well-liked stock rallies to a new high following a positive fundamental development. As the stock surges investors feel increasingly comfortable paying higher prices but there comes a point when the "story" of the stock fails to convert new believers. Slowly, the stock begins to drift lower as those seeking to lock-in profits outnumber those intrigued by the story. Although most of the fundamental news is still positive, many investors begin to question if the stock really is worth the prevailing market price and over time a substantial decline begins. This process creates an important technical peak top #1.
As the stock nears a twenty percent decline from the recent highs (this decline could reach fifty percent in bear markets) buyers begin to reassert themselves and the stock stabilizes and a reaction low occurs. From this point forward, the bias begins to tilt gradually higher. During this phase the stock may be the subject of positive Wall Street analyst comments, a new product announcement or legal victory. As the rally gains steam sentiment improves dramatically and new buyers begin to talk about certain new highs but those that purchased the stock at or near top #1 get ready to sell. These investors may have been waiting as long at 12 weeks for an opportunity to sell their positions without incurring a loss and they are not dissuaded by all of the new found bullish talk.
Just short of the old highs at top #1 aggressive selling begins on no specific news but in reality some investors that bought near top #1 have already begun to sell. The stock begins to work significantly lower on increased volume creating a second, well defined top - top #2. This large U-shaped pattern may look like a typical double top but for the purposes of this pattern, it is called the cup.
Noting key resistance at top #1 and top #2, speculators begin to initiate short positions. From a technical perspective, this is a very important part of the pattern. If the stock gains downside momentum and volume continues to increase, this could very easily become a double top but as the price works lower, volume slows, sellers seem to be losing the upper hand. At this point more positive fundamental news is released and the stock price rallies. With selling pressures satiated and the flow of fundamental news decidedly bullish volume increases dramatically and the stock works toward a fresh new high.
This very small U-shaped pullback is called the handle.
Speculators become frantic, they must cover short positions to cut losses but the supply of stock for sale has been significantly curtailed because investors that bought at top#1 have liquidated positions. The next session Wall Street analysts make positive comments and the stock surges to a new high on dramatically increased volume. Weeks later the stock trades at substantial new highs. The Cup with Handle is a bullish continuation pattern that marks a consolidation period followed by a breakout. As its name implies, there are two parts to the pattern: the cup and the handle. The cup forms after an advance and looks like a bowl or rounding bottom. As the cup is completed, a trading range develops on the right hand side and the handle is formed. A subsequent breakout from the handle's trading range signals a continuation of the prior advance.
1. Trend: To qualify as a continuation pattern, a prior trend should exist. Ideally, the trend should be a few months old and not too mature. The more mature the trend, the less chance that the pattern marks a continuation or the less upside potential.
2. Cup: The cup should be "U" shaped and resemble a bowl or rounding bottom. A "V" shaped bottom would be considered too sharp of a reversal to qualify. The softer "U" shape ensures that the cup is a consolidation pattern with valid support at the bottom of the "U". The perfect pattern would have equal highs on both sides of the cup, but this is not always the case.
3. Cup Depth: Ideally, the depth of the cup should retrace 1/3 or less of the previous advance. However, with volatile markets and over-reactions, the retracement could range from 1/3 to 1/2. In extreme situations, the maximum retracement could be 2/3.
4. Handle: After the high forms on the right side of the cup, there is a pullback that forms the handle. Sometimes this handle resembles a flag or pennant that slopes downward, other times just a short pullback. The handle represents the final consolidation/pullback before the big breakout and can retrace up to 1/3 of the cup's advance, but usually not more. The smaller the retracement is, the more bullish the formation and significant the breakout. Sometimes it is prudent to wait for a break above the resistance line established by the highs of the cup.
5. Duration: The cup can extend from 1 to 6 months, sometimes longer on weekly charts. The handle can be from 1 week to many weeks and ideally completes within 1-4 weeks.
6. Volume: There should be a substantial increase in volume on the breakout above the handle's resistance.
7. Target: The projected advance after breakout can be estimated by measuring the distance from the right peak of the cup to the bottom of the cup. As with most chart patterns, it is more important to capture the essence of the pattern than the particulars. The cup is a bowl-shaped consolidation and the handle is a short pullback followed by a breakout with expanding volume. A cup retracement of 62% may not fit the pattern requirements, but a particular stock's pattern may still capture the essence of the Cup with Handle.