A new way to trade cup handle patterns

American entrepreneur William J. O’Neil defined the C&H model in his classic 1988 book How to Make Money in Stocks. The technical requirements were added through a series of articles published in the “Investor Business Daily” that he founded in 1991. O’Neil includes the time frame measurement of each component, as well as a detailed description of the circular low point, giving the model a unique teacup appearance.

O’Neal pointed out the four stages of the cup and handled the breakthrough:

  • The security hit a significant high in an uptrend, which accelerated 1 to 3 months ago.
  • The next pullback will form a round bottom whose depth does not exceed the 50% retracement level of the previous trend. This marks the “cup”.
  • The next breakout attempt failed at the previous high, resulting in a second pullback, staying near the resistance, and grinding a smaller round bottom, which became a “handle”.
  • The safety returns to the resistance for the second time and bursts out, producing a measuring moving target equal to the depth of the cup.

Many cup and handle traders strictly abide by O’Neill’s construction rules, but there are many changes that can produce reliable results. In fact, the revised C&H model applies to all time frames, from intraday scalping to monthly market timing. Finding and trading these updated versions requires understanding crowd psychology at controversial price levels, as well as a well-trained eye that can see through the higher noise levels caused by electronic shutdowns in modern markets.

Cup handle is one of many chart patterns that traders can use to guide their strategies.

Deconstruct the cup and handle

Let us consider a typical market mechanism for a cup and handle scenario. The new rebound prints a high point, the price shifts into correction, and the relative strength oscillator flips to the sell cycle, encouraging strong bulls to exit positions. New buyers entered a correction at the 38.6% or 50% retracement level, and the previous upward trend is expected to resume. The stock rebounded and tested highs, attracting aggressive short sellers who believed that the new downtrend would lead to the collapse of the double top.

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This recovery volatility may end at the old high or exceed it by a few points, and then reverse and increase downward fuel because it traps two groups of buyers. First of all, the bulls who enter the depths of the pattern will feel nervous because they are betting on a failed breakthrough. At the same time, the bulls who were chasing breakthroughs watched the meager profits evaporate and were forced to defend their positions. Now, both groups are aiming for loss or profit reduction, and short sellers are complacent about doing their job well.

The situation changed again when the decline stalled within a broad trading range, giving way to a narrow sideways consolidation action. Short sellers lost confidence and began to cover, increasing the upward momentum, while the strong bulls who survived the recent pullback gained confidence. The relative strength oscillator has now entered a new buying cycle, encouraging one-third of the bulls to take risks. A positive feedback loop begins to run, and the price rises to the resistance level, completes the last segment of the pattern, and breaks through a strong uptrend.

The deconstruction mechanism tells us to look for C&H patterns in places that William O’Neill has never imagined, including 60-minute and monthly charts, because crowd psychology exhibits fractal characteristics and exhibits similar emotional behaviors over a larger and larger time frame. It also shows that as long as other structural factors attract new buyers and short sellers get discouraged and cover their positions, there is no need for a round bottom.

With this in mind, let’s take a look at three cup handle patterns that are not suitable for classic molds.

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Many years cup and handle

Wynn Resorts, Limited (WYNN) was listed on the Nasdaq Stock Exchange in October 2002. The price was close to US$11.50. Five years later, it rose to US$164.48. The subsequent decline ended within two points of the initial public offering (IPO) price, which far exceeded O’Neill’s requirements for the shallow cup highs in the previous trend. The subsequent wave of recovery reached its previous high in 2011, nearly four years after the first printing. The handle followed the classic callback expectation, found support at the 50% retracement of the circle, and returned to the high for the second time after 14 months. The stock broke out in October 2013 and rose 90 points in the following five months.

Cup and odd handle

Microsoft Corporation (MSFT) printed two non-traditional cup handle patterns in 2014. It reached the highest point of $41.66 in April and fell back to the 38.6% retracement of the last trend leg. The price formed a choppy but rounded bottom at this level and returned to a high point in June. It then grounded laterally in an integrated mode (the first blue box), which lasted more than five weeks, or nearly half of the time required to complete the cup segment.

According to O’Neill, the length of the handle should not exceed one-fifth to one-fourth of the length of the cup. This handle doesn’t look like an ideal pattern, but has the same purpose of staying near the previous high, shaking short sellers and encouraging new longs to enter positions. Please note that a deeper handle retracement (circular or otherwise) will reduce the probability of a breakout because the price structure strengthens the resistance of the previous high.

Safety finally broke out in July 2014, the upward trend matched the length of the cup, and the action was perfect. The rebound peak hit a new high, causing the callback to retrace 50% of the previous rebound, almost the same as the previous pattern. This time, the cup was printed with a V shape instead of a round bottom, and the price stagnated below the previous high. It was grounded laterally in an enlarged form (the second blue box), looked completely different from the classic handle for another three weeks, and then exploded. This rebound failed to reach the 50 measurement target, which was calculated by adding the four-point depth of the cup to the resistance line near $46.

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Cup handle

The 60-minute cup handle pattern provides an excellent timing tool when you want to buy a larger-scale trend that does not show a low-risk entry price on the daily or weekly chart. Akamai Technologies, Inc. (AKAM), after falling back to the main support level of the 200-day exponential moving average (EMA), consolidated below $62. It returned to resistance in early February 2015 and fell to a small rectangular pattern with support near $60.50. This rectangular handle is well above the 38.6% retracement level, allowing the bulls to maintain a dominant position before breaking through the measured moving target and hitting a 14-year high.

Bottom line

William O’Neal’s strict requirements for cup handle patterns more than 20 years ago can now be extended to various market scenarios in multiple time frames. This broader view allows us to shift our attention from the standard definition of the classic model to a narrow focus on crowd psychology, which supports its ability to predict large-scale breakthroughs.To learn more, check out technical analysis Course in Investment Encyclopedia Academy, Which includes videos and interactive content to help you identify these chart patterns and improve your trading skills.

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