Trading the Cup and Handle Pattern for Best Results

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We have discussed many different types of chart patterns to date. Today we will talk about a somewhat lesser known pattern but one that is still highly effective. I am referring to the Cup and Handle Pattern for Forex trading.  The following material will outline the unique structure of this pattern as well as a strategy for successfully trading it.

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Cup and Handle Pattern

The Cup and Handle pattern is a chart figure, which has a bullish potential. The pattern could appear after a price increase or a price decrease. Of course the pattern has its bearish equivalent, the Inverted Cup and Handle, which we will touch upon later as well.

It is important to remember that the pattern could act as a reversal or continuation signal. This depends on the price move prior to the pattern formation. We could have a bullish Cup and Handle after a bullish price move, in which case the pattern will be considered a continuation. If the bullish Cup and Handle comes after a bearish price move, it will act as a reversal pattern.

Structure of the Cup and Handle Technical Pattern

The Cup and Handle pattern is aptly named because this technical pattern actually resembles a cup with a handle on the chart. The pattern starts with a price decrease, where the Forex pair gradually changes its direction.

The change in the move is so gradual that the price action creates a rounded bottom on the chart. The beginning of the price decrease and the end of the price increase are approximately on the same level. This rounded structure is the Cup portion within the pattern.

Then comes the handle, which is expressed by a bearish price move. In many cases, the handle is locked within a small bearish channel on the chart.

Below you will see a sketch of the Cup and Handle formation:

Cup-and-Handle-technical-pattern-sketch

This is the shape of a Cup and Handle pattern. Sometimes, the beginning of the decrease and the end of the increase could diverge in terms of the level they are supposed to be located at. However, a small discrepancy between the tops of the two trends is admissible.

The handle should reach the mid. point of the Cup and Handle pattern. The decrease could stop a bit before the midpoint, or could go a bit below.

Cup and Handle Formations in Forex

There are two variations of Cup and Handle chart patterns in Forex based on their potential. There is the bullish Cup with Handle and the bearish Inverted Cup with Handle.

Bullish Cup and Handle Pattern

The bullish Cup and Handle pattern is the one we have been discussing so far. It starts with a bearish price move, which gradually reverses. The new bullish move finishes approximately around the top of the prior bearish move. Then the price action begins to create the handle, which is a bearish channel type structure.

When you confirm the pattern, the price is likely to break the channel of the handle, initiating a bullish move. This move has two targets. The first target equals the size of the channel during the handle. The second target equals to the size of the cup starting from the moment of the breakout.

Below you will see an example of a bullish Cup and Handle pattern:

Bullish-Cup-and-Handle-Pattern

This is the H1 chart of the most traded currency pair – EUR/USD. The time frame covered is August 10-18, 2016. In the middle of the image you see a bullish Cup and Handle pattern, which is illustrated with the blue lines on the graph.

See that the bottom of the pattern is rounded. The two tops of the cup are approximately on the same area. The handle starts right after the end of the cup. Notice that it is sloped downwards.

The price action breaks upwards and we apply the two targets. The first one is with the size of the handle and the second with the size of the cup. They are both applied from the moment of the breakout as shown on the image.

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Bearish Cup and Handle Pattern

As we said, the classic cup and handle pattern has its bearish equivalent – the bearish Cup & Handle, which is a mirror image of the standard Cup & Handle. Therefore, the bearish Cup and Handle is upside down.

The bearish Cup & Handle starts with a bullish price move, which gradually slows down and turns into a bearish move. The handle of the pattern is slanted upwards.

The confirmation of the pattern comes when the price action breaks the channel of the handle in the bearish direction. The first target of the pattern equals to the size of the bearish channel around the handle, applied downwards starting from the moment of the breakout. The second target equals to the size of the cup, applied downwards starting from the moment of the breakout.

This is how the bearish Cup with Handle pattern appears:

Bearish-Cup-and-Handle-Pattern

Here we are looking at the H4 chart of the GBP/USD Forex pair for May 5 – June 8, 2016. You will see the bearish Cup and Handle pattern on this chart. Notice that the pattern comes after a bullish trend, which means it acts as a reversal.

Also notice how the pattern starts with a bullish trend, which gradually reverses. In this manner, the created top is rounded. At the end of the reversed bearish move, the price reverses again and starts the creation of a bullish handle.

After the price breaks the handle downwards, we see the creation of a new bearish move. Thus, we apply the two targets as shown on the image.

Drawing the Cup and Handle

Drawing the Cup and Handle pattern might seem tricky at times. The reason for this is that the pattern cannot be drawn with a straight line. Due to the rounded bottom (or top) of the pattern, you should use a curved drawing tool.

If the pattern is bullish, take the two tops of the cup and stretch a curved line downwards until the rounded part reaches the low of the pattern. Then take the right side of the cup and draw the shape of the bearish handle.

If the pattern is bearish, take the two bottoms of the cup and stretch a curved line upwards until the rounded part reaches the top of the pattern. Take the right side of the cup afterwards and draw the shape of the bullish handle.

Cup with Handle Signal

The Cup with Handle formation has a very specific signal. When we get this indication, we can buy or sell the Forex pair depending on the potential of the pattern.

The Cup with Handle trigger signal is at the break out of the handle. The handle breakout acts as a confirmation of the pattern. When you identify the handle breakout, you can plot the two targets of the pattern – the size of the handle and the size of the cup.

Below you will see a valid Cup with Handle Signal:

Cup-with-Handle-Signal

Above you see the bearish Cup with Handle Pattern. The confirmation signal of the figure comes at the moment when the price action breaks the handle downwards. This is shown with the red circle on the chart. After the bearish Cup with Handle signal, you can start pursuing the bearish potential of the pattern.

Cup and Handle Trading System

Now that we have a better understanding of the structure of the pattern, we are going to summarize some trade management ideas around this pattern. Let’s take a look at a potential Cup and Handle trading system and the rules we need to follow when trading this pattern.

Opening a Trade

As we point out earlier, you would prefer to open a trade after confirming the Cup with Handle pattern. If the pattern is bullish, the signal should be a bullish breakout through the handle. In this case, you could open a long trade.

If the pattern is bearish, the signal should be a bearish break out of the handle. In this case, you could open a short trade.

Stop Loss

As with most if not all patterns, a stop loss is needed when you trade the Cup and Handle price pattern.

If you trade a bullish Cup with Handle pattern, you should place your stop loss order below the lower level of the handle. If you trade a bearish Cup with Handle your stop loss order should be placed above the upper level of the handle.

Take Profit

The take profit targets for the Cup & Handle corresponds to the two targets we mentioned earlier. Your first take profit target should be located on a distance equal to the size of the handle, starting from the breakout point. If this target is completed, you can then start pursuing the next target. The second target is located on a distance equal to the size of the cup, applied again from the moment of the breakout.

An additional option is to stay in the trade as long as the price is trending in your favor. You may not want to completely exit the trade, where the price move is offering more potential to add profit to your trade. Thus, you can watch for price action clues in order to extend the gains from the trade.

Trading the Cup and Handle Chart Pattern

Now let’s demonstrate the bullish and the bearish Cup and Handle strategy in action. The examples below will help clear out any questions you may have related to trading the Cup and Handle pattern in Forex.

Bullish Cup and Handle Trading Example

We will start with the bullish Cup and Handle trading example. The image below will show you how to trade this version of the pattern from an actual chart:

Bullish-Cup-with-Handle-Trading-Strategy

This is the H4 chart of the AUD/USD Forex pair for Sep 3-21, 2016. The image shows a bullish Cup with Handle chart figure with the blue lines on the chart.

The confirmation of the pattern comes in at the green circle at the moment when the price action moves above the handle. You would typically look to buy the AUD/USD Forex pair when the candle closes above the handle.

The stop loss order of this trade needs to be placed below the lowest point of the handle. This is shown with the red horizontal line on the image. The magenta arrows and lines represent the two targets on the chart.

As you see, the price reached the first target of the pattern prior to the entry, had you waited for the candle close to enter. Sometime afterwards, the price action reaches the second target on the chart. You have the option to close your entire position at this second take profit target. However, you could opt to hold a portion of the trade for further gains if you see price action continuing to trend upwards. The yellow line on the chart is an upward trend line, which measures the bullish activity of the price action. You could hold the trade as long as the price action is located above the yellow bullish trend line. The break through the trend line is shown in the red circle on the chart, which would signal an opportune time to close out the trade in its entirety.

Bearish Cup and Handle Trading Example

Let’s now switch to the opposite version of the pattern. Below you will find a bearish Cup and Handle trading example:

Bearish-Cup-with-Handle-Trading-Strategy

This is the hourly chart of the USD/CAD Forex pair for March 25-30, 2016. The image illustrates the way a bearish Cup and Handle pattern could be traded.

The pattern is illustrated in blue on the chart. The rounded part is the Cup and the small bearish channel is the handle. The confirmation of the formation is illustrated with the small green circle when the price action breaks the handle downwards. This would be an advantageous time to sell the USD/CAD Forex pair.

The stop loss order of the trade needs to be placed above the handle. Its location is shown with the red horizontal line on the chart.

The two targets are applied using the two magenta arrows and horizontal lines. As you can see, the price action reaches both of these targets in the next two hourly periods. The trade could be closed afterwards. However, if you decided to keep a portion of the position open, how might you manage the trade?

See the second big bearish candle, which reaches the second target. The high and the low of this candle could be used to draw a horizontal support / resistance zone on the chart. The trade should be closed if the price action breaks the upper barrier. You can even adjust your stop loss order right above the upper level of the zone.

As you see, the price action breaks to the lower level of the S/R zone, which indicated that the price will probably continue in the bearish direction. Note the large bearish move on the chart following the breakdown.

Download the short printable PDF version summarizing the key points of this lesson….Click Here to Download

Conclusion

  • The Cup and Handle is a chart pattern, which has a bullish potential.
  • The pattern consists of two elements:
    • The cup – bearish price action, which gradually changes direction
    • The handle – bearish price action, which starts right after the cup and ends around the midpoint of the cup
  • The two elements create a pattern, which resembles a cup with handle on the chart.
  • The Cup with Handle pattern has its bearish equivalent, and is referred to as an Inverted Cup and Handle formation.
  • The Cup with Handle confirmation comes when the price breaks out of the handle.
    • If the pattern is bullish, you should wait for bullish confirmation and you should trade the pattern long.
    • If the pattern is bearish, you should wait for a bearish confirmation and you should trade the pattern short.
  • To trade the pattern successfully, you could implement the following rules:
    • Open a trade:
      • If the pattern is bullish, buy when the price breaks the handle upwards.
      • If the pattern is bearish, sell when the price breaks the handle downwards.
    • Put a stop loss:
      • Below the handle if the pattern is bullish.
      • Above the handle if the pattern is bearish.
    • Take profit using the two targets rule:
      • Target 1 – equals to the vertical size of the handle applied at the moment of the breakout through the handle
      • Target 2 – equals the vertical size of the cup applied at the moment of the breakout through the handle.

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