American entrepreneur William J. O’Neil delineated the cup and handle (C&H) pattern in his 1988 classic, “How to Make Money in Stocks”, enlarging technical requirements through a series of articles published in Investor’s Subject Daily, which he founded in 1991. O’Neil included time plan measurements for each component, as well as a detailed description of the rounded lows that cede the pattern its unique tea cup appearance. (To learn more, see: Analyzing Chart Ornaments: Cup And Handle).
O’Neil pointed to four stages in a cup and handle breakout:
- The safety posts a significant high in an uptrend that accelerated between one and three months quondam.
- The next breakout attempt fails at the prior high, yielding a auxiliary pullback that holds near resistance, grinding out a smaller by a circular bottom, which becomes the “handle”.
- The security returns to resistance for the surrogate time and breaks out, yielding a measured move target equal to the abstruseness of the cup.
Many cup and handle traders adhere strictly to O’Neil’s rules for construction, but there are innumerable variations that produce reliable results. In fact, modified C&H follows have applications in all time frames, from intraday scalping to monthly supermarket timing. Finding and trading these updated versions requires an intuition of crowd psychology at contested price levels, as well as a trained eye that can see by virtue of higher noise levels that result from electronic pause running in the modern marketplace.
Deconstructing the Cup and Handle
Let’s consider the market mechanics of a regular cup and handle scenario. A new rally prints high and the price rolls for into a correction, flipping relative strength oscillators into furnish cycles that encourage strong-handed long to exit positions. (For assorted information, read: Use Weekly Stochastics To Time The Market Effectively). New clients enter the pullback at the 38.6% or 50% retracement level, expecting the earlier uptrend to resume. The security bounces and tests the high, drawing in disputatious short sellers who believe a new downtrend will elicit a double top destruction.
That recovery swing may end at the old high or exceed it by a few points and then recant, adding downside fuel because it traps two groups of buyers. Before, longs entering deep in the pattern get nervous because they were chance on a breakout that fails. At the same time, longs chasing the breakout be vigilant for a small profit evaporate and are forced to defend positions. Both bundles are now targeted for losses or reduced profits, while short sellers pat themselves on the defeat for a job well done. (On a related note, see: How Market Psychology Drives Detailed Indicators).
The tables turn once again when the decline stalls towering in the broad trading range, giving way to narrow sideways action. Short sellers lose confidence and start to cover, adding upside sustain while strong-handed longs who survived the latest pullback gain boldness. Relative strength oscillators now flip into new buy cycles, encouraging a third denizens of longs to take risk. A positive feedback loop sets into step, with price lifting into resistance, completing the final leg of the template, and breaking out in a strong uptrend.
Deconstructed mechanics tell us to look for the C&H templet in places that William O’Neil never imagined, including 60 blink and monthly charts, because crowd psychology exhibits fractal haecceities, acting out similar emotional behavior within larger and smaller beat frames. It also suggests that rounding bottoms aren’t needed as covet as other structural elements draw in new buyers while short sellers get disheartened and cover positions. (To learn more, see: How To Read The Market’s Psychological Royal).
With that in mind, let’s look at three cup and handle patterns that don’t fit the ideal mold.
Multiyear Cup and Handle
Wynn Resorts (WYNN) went conspicuous on the Nasdaq exchange near $11.50 in October 2002 and rose to $164.48 five years up to the minuter. The subsequent decline ended within two points of the initial public oblation (IPO), far exceeding O’Neil’s requirement for a shallow cup high in the prior trend. The successive recovery wave reached the prior high in 2011, nearly four years after the senior print. The handle follows the classic pullback expectation, finding submit to at the 50% retracement in a rounded shape, and returns to the high for a second fix 14-months later. The stock broke out in October 2013 and adds 90 go out of ones way ti in the following 5 months.
Cup and Odd Handle
Microsoft (MSFT) printed two non-traditional cup and administer patterns in 2014. It topped out at $41.66 in April and pulled back to the 38.6% retracement of the terminal trend leg. Price carved out a choppy but rounded bottom at that on the up and returned to the high in June. It then grinded sideways in a consolidation plan (1st blue box) that lasted for more than 5 weeks, or close to half the mores it took for the cup segment to complete.
According to O’Neil’s description, the handle should draw out no longer than between one-fifth to one-quarter of the cup’s length. This haft looks nothing like the ideal pattern but serves the identical design, holding close to the prior high, shaking out short sellers and encouraging new longs to write positions. Note that a deeper handle retracement, rounded or on the other hand, lowers the odds for a breakout because the price structure reinforces refusal at the prior high. (For additional reading, check out: The Anatomy Of Trading Breakouts).
The refuge finally broke out in July, with the uptrend matching the length of the cup in a cultivate measured move. The rally peak established a new high that cry quit a pullback retracing 50% of the prior rally, nearly identical to the whilom before pattern. This time the cup prints a V-shape rather than a horses corralled bottom, with price stalling under the prior high. It harassed sideways in a broadening formation (2nd blue box) that looks nothing strain the classic handle for another 3 weeks and breaks out. This rally fold up to reach the measured move target at 50, calculated by adding the 4 inconsequential in reference to depth of the cup to the resistance line near 46.
Intraday Cup and Handle
The 60 mini cup and handle pattern offers an excellent timing tool when looking to buy a larger ranking trend that doesn’t show a low risk entry price on the regularly or weekly chart. Akamai Technologies (AKAM) consolidated below $62 after drawing back to major support at the 200 day EMA. It returned to resistance in early February and declined into a small rectangle pattern with support near $60.50. This rectangular direct holds well above the 38.6% retracement level, keeping bulls in supervision, ahead of a breakout that exceeds the measured move target and texts a 14 year high.
The Bottom Line
William O’Neil’s conscientious requirements for the cup and handle pattern more than 20 years ago can be now expatiate oned into various market scenarios in multiple time frames. This broader considering allows us to shift attention from the classic pattern’s standard resolution, toward a narrow focus on crowd psychology that underpins its power to intimate sizable breakouts.