Cup and Handle Pattern Trading Strategy Guide

How to Make Money in Stocks: A Winning System in Good Times and Bad. 

This post was originally posted here. The writer, Rayner Teo is a veteran community member and blogger on InvestingNote, with a username known as @Rayner and has close to 800 followers.

This is a powerful chart pattern that’s used by stock traders to capture explosive breakout moves — where the stock price could increase 1000+% within a few years. 

Insane right?  

That’s why in this trading strategy guide, I want to dive deep into the Cup and Handle pattern so you, yourself, can find your own “monster” breakout trades.

So here’s what you’ll learn:

• What is the Cup and Handle pattern and how does it work
• Don’t make this common MISTAKE when trading the Cup and Handle pattern…
• How to better time your entries when trading the Cup and Handle pattern
• How to set a protective stop loss so you don’t lose everything on one trade
• Cup and Handle: How to exit your winners and ride massive trends
• Cup and Handle: How to capture a swing for consistent profits
• Advanced trading technique: How to enter the breakout BEFORE the breakout

Are you excited?

Then let’s get started…

What is the Cup and Handle pattern and how does it work?

The Cup and Handle pattern is a bullish reversal chart pattern (it could be after a correction or a long-term downtrend).

There are 2 parts to it:

The Cup — the market show signs of bottoming as it has bounced off the lows and is making higher highs towards Resistance

The Handle — a tight consolidation is formed under Resistance

Cup and Handle recognition (an example)…

Tesla Daily Timeframe:

Here’s the idea behind the Cup and Handle pattern.

After the Cup is formed, the market has shown signs of bottoming as it makes higher lows towards Resistance.

Next, how the price reacts at Resistance is important because it tells you whether there is still selling pressure lurking around.

If you see a large sell-off from Resistance, it invalidates the pattern, and it tells you the market is not ready to head higher.

But, if you noticed that the price is holding up nicely at Resistance, then it’s a sign of strength as it tells you buyers are willing to buy at these higher prices.

Finally, when the price breaks out of Resistance, the cup and handle pattern is “confirmed”, and the market could move higher.

Pro Tip:

The best cup and handle patterns have a shallow retracement on the handle (not more than 1/3 of the cup).

Don’t make this common MISTAKE when trading the Cup and Handle pattern…

Here’s the thing:

To form the handle, the price must approach Resistance and form a tight consolidation (otherwise known as buildup).

At this point, many traders would think to themselves…

“The price is at Resistance, time for me to go short.”

Now, that’s fine if the price made a strong momentum move into Resistance and it gets rejected strongly.

But, if the price approaches Resistance and forms a buildup, or it made higher lows into Resistance, then you want to be careful.

Because this is a sign of strength telling you there are buyers willing to buy at these higher prices.

The last thing you want to do is short the market because it’s likely to breakout higher.

Here’s an example…

Tesla Daily Timeframe:

This is a universal concept, and it doesn’t just apply to Cup and Handle pattern.

So whenever you see a buildup or higher lows into Resistance, it’s a sign of strength.

Cup and Handle chart pattern: Where do you enter your trade?

The Cup and Handle pattern confirmation comes when the price breaks above the “handle” — and that’s where you can enter a trade.

Still, there are 2 things to consider:

1. Do you want for a close?

2. Do you place a buy stop order?

Let me explain the pros and cons of both approaches…

Do you wait for the candle to close before entry?

The good thing about waiting for the close is it’s less prone to false breakout.

However, sometimes, the market closes much higher and you get a poor entry point. This results in a wide stop loss and a smaller position size on your trade.

An example…

Zoom Daily Timeframe:

 

Do you place a buy stop order?

The good thing with a buy stop order is your entry will just be above the highs of the “handle”, and if the breakout is real, that’s one of the best prices to get in.

However, the market could do a False Breakout and you are long the highs.

Now you might be wondering:

“Which approach is best?”

Well, there’s no best approach.

You should go with the one you’re most comfortable executing — this results in less error and more consistency in the long run.

Cup and Handle chart pattern: Where do you place your stop loss?

Now whenever I place a stop loss, it always follows this rule:

“Your stop loss should be placed at a level where if the market reaches it, your trading setup is invalidated”.

This means when you put on a trade, it’s based on a trading setup (or chart pattern).

And when the trading setup is “destroyed”, the reason to stay in the trade is no more.

So, the question is…

Where will the Cup and Handle pattern be “destroyed”?

If you ask me, it’s when the price breaks below the low of the handle, thereby invalidating the Cup and Handle pattern.

Now, you don’t want to put your stop loss at the exact low of the handle because the market could trade into that area of value and reverse higher.

Instead, give it some buffer below the handle like 1 ATR below it.

Here’s an example of where to set your stop loss…

Netflix Daily Timeframe:

Does it make sense?

Great!

Then let’s move on…

Cup and Handle chart pattern: How to exit your winners and ride big trends

As you know:

The Cup and Handle is a bullish reversal chart pattern.

This means it could be the start of a NEW uptrend and the last thing you want to do is cut your profit short.

So what am I suggesting?

Ride the trend!

And here are 2 common techniques you can use:

1. Moving Average
2. Structure

Here’s how it works…

1. How to use Moving Average and ride big trends

Here’s how…

In a trending market, the price can remain above a Moving Average for a long period of time.

So, what you’ll do is trail your stop loss as the price remains above the Moving Average — and exit when the price closes BELOW the Moving Average.

Here’s an example…

Palladium Daily Timeframe:

You’re probably wondering:

“Which period do I use?”

The general guideline is this…

20-period Moving Average to ride the short-term trend.

100-period Moving Average to ride the medium-term trend.

200-period Moving Average to ride the long-term trend.

2. How to use Structure and ride massive trends

Here’s the thing:

For a trend to continue higher, it MUST make higher highs and lows.

If it doesn’t, then chances are it’s in a range or about to reverse lower.

With this in mind, you can trail your stop loss on the previous swing low because if the market wants to continue higher, the previous swing low shouldn’t be “broken”.

Also, give your stop loss some buffer below the swing low as you don’t want the price to breach the lows, and only to reverse higher.

Here’s what I mean…

ROKU Daily Timeframe:

Next…

Cup and Handle chart pattern: How to capture a swing for consistent profits

Now, if riding trend is not your thing, then you can capture a swing.

If you don’t know what a swing is, it means capturing “one move” in the market, and that’s it.

And usually, you exit your trades just before the opposing pressure steps in.

So for example:

If you’re long, you want to exit your trades before the swing high or Resistance.

If you’re short, you want to exit your trades before swing low or Support.

If you trade chart patterns, you want to exit your trade when the pattern is completed.

So, how do you know a chart pattern is completed?

By using the price projection technique.

Here’s how it works for the Cup and Handle chart pattern:

1. Identify the distance from the high to the low of the cup

2.Project the distance from the breakout level and that’s your target profit

An example…

ROKU Weekly Timeframe:

Does it sense?

Great!

I’ve got one last trick for you…

Advanced trading technique: How to enter the breakout BEFORE the breakout

So…

The idea behind the Cup and Handle pattern is to trade the breakout when the price breaks above the “handle”.

But imagine this:

What if you can go long before the price breaks out higher, how much more profitable would it be for you?

And is it possible?

Heck yes!

That’s why I want to introduce to you this advanced technique: The Pre Breakout.

Here’s how it works:

1. Pay attention when the handle is being formed (the tighter the volatility contraction, the better)

2. Go down to a lower timeframe (a factor of 4 to 6) and look for a False Break at Support

3. If there’s a False Break at Support, go long with a stop loss 1 ATR below the lows

Here’s an example…

Disney Weekly Timeframe: A volatility contraction on the higher timeframe

And on the lower timeframe, there’s a False Break at Support which offers a long entry…

Disney Daily Timeframe:

If you want to learn more, go check out this training below…

So here’s what you’ve learned in this Cup and Handle trading strategy guide:

• The Cup and Handle is a bullish reversal chart pattern which can signify the start of a new uptrend
• A common entry technique is to trade the break of the handle and go long
• You can set your stop loss 1 ATR below the handle so you don’t get stopped out prematurely
• I suggest trailing your stop loss as the price moves in your favor so you can ride the move higher
• The Pre Breakout technique allows you to go long before the breakout occurs. This is done by identifying a False Break on the lower timeframe

Now here’s my question to you…

What do you think of the Cup and Handle chart pattern?

Once again, this article is a guest post and was originally posted on Rayner‘s profile on InvestingNote. 

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