A cup and handle formation

by | Mar 2, 2020 | Learning Module 4, Topic 4: Investment Analytics | 0 comments

This is part of series on technical chart patterns. It is called a cup-and-handle formation, easy to see why!!! The cup formation is the shape of the letter “U” and the handle has a slight downwards tilt. A cup and handle formation signals a bullish phase, and it offers buying opportunities at different price points as we describe below. It is a pattern drawn with Japanese Candlesticks and is much sought after by technical analysts. In their language, a cup-and-handle formation is one of several “continuation” patterns, which simply means that prices will continue to move in the same direction that the chart indicates

Chart is reprinted courtesy of Stockcharts.com and is also available here.

The first step in this cup-and-handle formation is there be an uptrend of the stock (the portion of the cup towards the handle!). But how much of an uptrend, and what about before it? Many technical analysts are of the view that the stock must decline 15% to 30% before the formation of the base or bottom of the cup, and others feel that the stock must run up at least 30% These are not hard and fast numbers, you should adapt them to the situation you are examining. The two top edges of the cup (where the blue-line is drawn) indicate the resistance level. A bit of a drop near resistance for the handle to take shape (sic!) After that there is a breakout and the stock price starts to increase again.

With so many drops and pops, where is the buying opportunity?  One place could be the bottom of the cup, and some suggest that institutional investors buy at the bottom of the cup! Easy to say, but the cup hasn’t formed yet, and may not even form!  A second buying opportunity presents itself at the lower tip of the handle, after which an upward breakout happens. This may be a safer place to initiate that buying!

So how long do these formations take? Sometimes years, sometimes between a month and a year.  In, 1988, William J. O’Neil first identified and illustrated the cup and handle formation in his book – How to make money in stocks. He published a series of follow up articles in his publication – Investor’s Business Daily where he spelt out further technical requirements. He spelt out the time frames for each part of the formation and the rounded bottom of the cup formation.

He explained that the downtrend portion of a cup formation along with the bottom formation could last from four days to four weeks and the selling pressure contributes to this. After this the stock price advances higher. Beware of V-shaped cups, the longer the cup takes to form, and the more of a U-shape it displays, the more reliable is the signal. Likewise, also be wary if the cup is very deep and the handle is very deep.

As with many technical patterns, it is better if the declining portion of the cup happens at low volume. Volume should also be lower than average in the base of the cup and start rising when the stock price starts increasing. The handle itself should witness lower volume. The volume should be really high in the upward breakout after the handle.

As another example, we show you CZR, a Nasdaq company. Notice the size of the breakout.

Chart is reprinted courtesy of Stockcharts.com and is also available here

As always, our usual cautions apply- technical patterns are not cast in stone and are not 100% accurate. There are merely guidelines. Use them in conjunction with other confirming evidence. We showed you above how volume can be used to provide some confirmation. We hope you have enjoyed this piece and will become regular readers of the PIE-BLOG and our other content!