Chart Pattern Recognition Series Cup and Handle Short-term Bullish Continuation
The Cup and Handle pattern has long been my favorite patterns to trade. This short-term bullish continuation pattern gets its name from looking like a rounded cup with a handle on the right side. The primary reason that I like this pattern so much is the low failure rate it sports compared to other chart patterns. This is especially true when dealing with industry leaders. The average rise for this pattern is an apatizing 34%.
One of biggest mistakes that amateur traders make is being quick to jump to the conclusion that just because a pattern they found is rounded, that it is a cup and handle. The cup and handle pattern has a lot of criteria and should not be confused with several other patterns out there that look similar to it. Lets run through the some very important criteria to make a pattern a true cup and handle. If the pattern fails to meet anyone of these, it should not be considered a cup and handle.
1.) Stock price rise leading into the left cup lip is at least 30%.
2.) Cup duration is between 7 and 65 weeks. I prefer to see a cup that is at least 5 months in length with 6 months being ideal. I personally only trade cup and handle patterns of 6 months in duration.
3.) Cup depth is between 15% to 35%.
4.) Handle duration is between 1 to 2 weeks, with a 1-week minimum.
5.) Handle carries a downward volume trend.
6.) Handle forms in the upper half of the cup on the right side.
The buy signal on the cup and handle pattern comes when the price closes above the right cup rim on significant volume breakout. Handles that are shorter than 23 days show better performance post breakout. The volume is also a U-shaped pattern. One thing to watch out for is that cups often form within cups. These are the ones that are often mis-interpreted by traders.
As you can see there are many criteria for this pattern and hence the reason that it gets incorrectly identified so often. One thing you can do to protect yourself is to set your stops when attempting to trade this pattern. A good place to put your stop is just below the handles lowest traded price. As the price raises, be sure to raise your stop as this pattern has a tendency to raise 10% - 15% before reversing and heading down quickly.
I have tried to find a real time example of the Cup and Handle pattern but unfortunetly that is easier said then done. A setup that caught my attention as a potential C&H pattern (but has failed to prove so) is Raytheon Company (NYSE: RTN). Raytheon Company is a world leader in developing defense technologies and converting those technologies for use in commercial markets. Fundamentally, Raytheon looks solid with a strong P/E, Cash Flow, EPS and Price Rank. The industry (Conglomerates .CCO) has shown a steady increase in institutional interest. These solid fundamentals help increase the reliability that the chart pattern will hold true.
The problem with this chart is that the price decline after the initial 30+ percent rise into the left cup lid is not as steep as I normally like to see. I prefer a minimum of 20% with a depth closer to 30% being more attractive. Here we have a relatively shallow cup. I would still wait on the breakout volume to confirm the pattern but this is a good example of the sort of setup that I look for. I would also like to point out that this is not the most ideal looking handle as it is too long and the volume has yet to breakout. Remember not to get too trigger happy and wait for buy signals before pulling the trigger here.
Good luck trading this pattern. It is one of my favorites to trade and if you find any other opportunities that match the above criteria, please share them as I am always interested!