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Last week we took a look at the head and shoulders trading pattern. This time we’re focusing on what is known as the “cup and handle.” Unlike the head and shoulders pattern, a cup and handle can indicate the continuation of an established bullish trend or the reversal of a downtrend. It is used by traders to identify buying opportunities.
Identifying the Cup and Handle
The cup and handle pattern is one of the easiest to identify. As its name suggests, the pattern resembles a teacup, with the cup on the left and its handle on the right. The cup should be a nice symmetrical bowl shape, with the handle showing a sideways or slight downward drift. As with a real cup, the handle should be smaller than the cup (less than half its height, ideally within the upper third).
As a general rule, the longer and smoother the cup formation, the stronger the handle signal. Cups with sharp “V” shaped bottoms are often avoided by traders as they do not indicate a consolidated price bottom and carry the risk of further decline. Cups should also not be overly deep. Overall, the volume should be relatively low. There should be a decrease as the price trickles down the left side of the cup. At the base of the cup, it should remain lower than average. As the price begins to scale the right side of the cup to test the previous high, volume should increase slightly.
Trading patterns cannot be named with 100% confidence until their formation is complete; the cup and handle is no different. An upward trend breaking out from the handle is required. Experienced traders can often anticipate the pattern before it fully plays out.
Similar to the head and shoulders pattern, there is also an inverted version of the cup and handle. It indicates a bearish downtrend continuation. The cup forms upside-down and the handle indicates an upward drift. This drift proves temporary, and the price breaks downward from the handle.
Trading the Cup and Handle
Generally speaking, cup and handle patterns form over several months. The cup can take one to six months to form, with the handle typically showing itself within a month of the cup’s completion. Typically, a slow-forming cup and handle will be followed by a larger rally than a cup and handle that formed quickly. The reason being that a cup and handle represents the testing of a market by investors: a longer confirmation of a bullish market is much more reassuring than a short one.
When entering a cup and handle trade, most traders wait for the handle to form. The handle often forms a sideways or descending channel or triangle. Once the price moves out of the handle channel or triangle, the pattern is seen as complete, indicating a buy signal.
To be successful over the long term, traders using tools such as the cup and handle trading pattern usually set clearly-defined price targets and stop-losses.
Many traders estimate price targets for cup and handle patterns by measuring the height from the bottom of the cup to the height of the right peak of the cup and adding this to the height of the breakout point of the handle. For example, if a cup forms between $80 and $100 and the breakout point is $90, the target would be $110.
Setting a proper stop-loss is arguably more important than setting a price target. If for some reason, the price were to drop instead of rallying following a breakout from the handle, a stop-loss limits the risk of the trade. Traders usually place stop-losses below the lowest point of the handle (i.e., ideally within the top third of the cup).
There are several tools available to investors to help identify trading opportunities. None of them are guaranteed to make you money. Whether you prefer to use fundamental analysis, technical analysis, or a mixture of both, it’s imperative to remain well-informed and make your own decisions – particularly in the high-risk cryptocurrency space.