Cup And Handle Trading Strategy: (Backtest And Example)
Chart pattern recognition is one of the most popular techniques employed by chartists and technical traders; they constantly study and analyze price movements in hopes of detecting patterns that show the next most probable price movement. While there are many different types of chart formations out there, the cup and handle pattern strategy is one you may want to add to your trading arsenal because of its reliability. Let’s find out what it is.
The cup and handle pattern strategy is a formation on the price chart of an asset that resembles a cup with a handle. It is a bullish continuation pattern that marks a consolidation period followed by a breakout.
As its name implies, the pattern consists of two parts — the cup and the handle. The cup looks like a “u” or a bowl with a rounded bottom that forms after a price rally, while the handle is a trading range that develops on the right-hand side of the cup. The pattern completes when the price breaks out from the handle’s trading range to signal the continuation of the previous rally.
In this article, we backtest the cup and handle pattern strategy. Because the cup and handle pattern is difficult to define with strict buy and sell rules, we refer to other research.
Let’s dive in to learn how to spot this pattern.
Cup with handle pattern
First, we want to write that the cup and handle pattern is also called cup WITH handle pattern. They are the same pattern and formation.
What is a cup and handle pattern?
The cup and handle pattern is a formation on the price chart of an asset that resembles a cup with a handle. As its name implies, the pattern consists of two parts — the cup and the handle. The cup has the shape of a “u” or a bowl with a rounded bottom that forms after a price rally, while the handle is a trading range that develops as a slight downward drift on the right-hand side of the cup. Further down in the article we have several charts to show how it looks like in a chart.
The pattern is a bullish continuation formation that marks a consolidation period, with the right-hand side of the pattern typically experiencing lower trading volume. The cup part of the pattern forms after a price rally and looks like a gradually rounded bottom of a bowl. As the cup is completed, a trading range develops on the right-hand side, which becomes the handle A subsequent breakout from the handle’s trading range signals a continuation of the previous price rally.
Thus, the cup and handle pattern is considered a bullish signal extending an uptrend, so technical traders and chart analysts use it to spot opportunities to go long.
The cup and handle pattern is pretty famous and known. One of the reasons for that belongs to William O’Neil. O’Neil is the innovator of the CANSLIM method and one requirement was that the stock must form some kind of a cup and handle pattern. O’Neil was, to our knowledge, the first to describe the pattern, in his 1988 bestseller and classic How to Make Money in Stocks. He has been adding technical requirements through a series of articles published in Investor’s Business Daily, which he founded in 1984. Following his principles, traders using the pattern should place a stop buy order slightly above the upper trendline of the handle part of the pattern.
What are the rules for the cup and handle pattern?
The criteria that qualify the cup and handle pattern include:
- The trend: Being a continuation pattern, the pattern must occur in an existing trend. But the pattern works best in a new trend, not an old one.
- The cup: The cup should have the shape of a “U” and resemble a bowl with a rounding bottom. It should never have a “V