What is the Cup and Handle pattern and how to trade it

In trading and investing, it is common to use different tools and patterns to predict how currency prices will change. One effective pattern is the Cup and Handle pattern. It looks like a cup with a handle, and it can show if a currency's price is about to go up or down. Let’s talk about this pattern, how to spot it, and what advantages and disadvantages come with using it in trading.

What is the Cup and Handle pattern?

The Cup and Handle pattern was first introduced by a trader named William O'Neill in 1988 in his book about making money on stocks. Since then, many traders have learned about it and used his ideas to understand this pattern better.

The Cup and Handle pattern anatomy is shown below:

1. First, the currency's price goes up, then it drops down a bit, making a 'U' or 'V' shape on the chart.
2. After that, the price doesn't change much for a while; it moves sideways. This part looks like the handle of the cup.
3. Finally, if the price goes up again after this sideways movement, it could mean the currency's price is likely to keep rising.

Here are the crucial Cup and Handle pattern characteristics:

Traders like this pattern because it shows that the price might be getting ready to go up again after taking a little break. However, it's not always right, and sometimes it might not work out as expected. So, traders usually check other signs, too, before making decisions.

Types of Cup and Handle patterns

Below are the three variants of this chart.

Cup and Odd Handle

The Cup and Odd Handle pattern looks like a cup with a bit of a 'V' shape at the bottom instead of being round. That 'V' part is the Cup, and a little line looks like a Handle sticking out of it. This Handle is shorter than the Cup and doesn't look like a standard handle, but it still shows that prices are decreasing slightly. When this pattern happens, it usually starts after the currency's price has dropped a lot. Then, it goes back up quickly to a new high. After that, there's a slight dip again before it starts rising.

For traders, this pattern is a good sign to buy because it means prices might go up a lot after the slight dip.

Multi-year Cup and Handle

The Multi-year Cup Handle is a pattern you see in the market that takes a few years to form. It starts with a significant drop in prices, creating a shape like a 'V' at the bottom, like a cup. After that drop, the prices start to go back up, but then there's a little dip again, which is the 'handle' part of the pattern. This dip can last several months to a year before prices rise again. When prices finally go up, it's a sign for traders that it might be a good time to buy.

This pattern is great for people who want to invest for a long time and look at how prices have moved in the past to make their decisions. It helps them spot good investment opportunities when they see this trend forming over the years.

Intraday Cup and Handle

The Intraday Cup and Handle pattern is a trading signal that happens in a short timeframe, specifically on a chart that shows prices changing every hour. It helps traders find good moments to buy when the price increases. Let's say you have a cup shape made of two parts: the 'cup' and the 'handle'. The cup looks like a flat 'U' where the price decreases a bit and then comes back up. After that, there's a slight dip, which is the handle part. Since this pattern happens over just a few hours, you see more ups and downs in prices compared to more extended patterns.

So, it looks squished together. When traders spot this pattern during an upward trend, they think it's a good sign that prices will go up again soon, making it a good time to buy.

Advantages of trading the Cup and Handle pattern

The Cup and Handle pattern offers several strong points for traders and investors:

• This pattern shows clear zones where traders can buy (when the price breaks out) and where to sell (to avoid losing money).
• Since this pattern happens when prices are already going up, there's a lower chance that it will trick traders into thinking that a bullish trend may form.
• Traders can measure how high the cup goes to predict how high the price might go after it breaks out, helping them decide when to sell for a profit.

Disadvantages of the Cup and Handle pattern

The Cup and Handle pattern has some downsides, too:

• Sometimes, the pattern can fail. Since no strategy or pattern is 100% perfect It might fail, thus traders are advised to use a stop loss.
• Some traders see the pattern differently. One trader might think it's there on the chart, while another might not, leading to different decisions.
• This pattern doesn't form quickly. Traders might have to wait a long time—sometimes weeks or months—before it shows up.

How to identify the Cup and Handle pattern

Identifying the Cup and Handle pattern requires a keen eye for chart patterns and an understanding of price action dynamics. Take the following steps to spot it:

1. Look for the Cup shape. Check the price chart for a curve that looks like a cup. It should have a rounded bottom, and the highs on both sides should be about the same.
2. Find the Handle. After the cup shape, there should be a small dip (like a handle) where the price decreases slightly. This handle should be shorter than the cup.
3. Check the size of the Handle. The Handle shouldn't go down more than half the way of the cup's depth. It should also have a line above it that slopes down.
4. Watch for the breakout. Once the handle is formed, if the price goes up and breaks through that line with more people buying (higher trading volume), it could mean prices are likely to rise. So, you're basically looking for a cup shape followed by a little dip and then hoping for a price jump.

How to use the Cup and Handle pattern in Forex

The scheme looks generally the following way:

1. First, look for a price chart that shows a U-shaped curve ('the cup'). After that, you want to see a small dip or drop that looks like a handle.
2. Once you see the Handle, you need to wait until the price goes above a certain point (called the resistance level) and more people start buying. This is called a 'breakout'.
3. After the breakout, you can predict where the price might go. To do this, measure how deep the cup is (the difference between the high and low points) and add that to the breakout price. For example, if the cup goes from $40 to $50, the depth is $10. If it breaks out at $50, your target price would be $60: ($50 + $10).
4. Finally, to protect yourself from losing too much money, set a stop-loss order. This is like a safety net that tells you to sell if the price drops too low, either below the Handle or the bottom of the Cup.

In the chart above, we see the Cup and Handle pattern, where there are:

Risk management

Only sometimes you see a Cup and Handle chart will the price go up as hoped. Sometimes, it might not break out at all or could even go down. That's why it's crucial for traders to consider the following risks:

What happens after a Cup and Handle pattern forms

When you see a Cup and Handle pattern on a chart, it usually means the price of an asset is likely to go up. This happens when the price breaks above a certain point (called 'resistance'), showing that more people want to buy it. However, this pattern doesn't happen overnight. It can take weeks or even months to form.

Example of trading the Cup and Handle

Let's take the example of the USDJPY currency pair. Between October 2022 and November 2023, its price went through a shape that looks like a cup with a handle. Over a year period, the price dropped to around 127.168, then slowly rose to about 149.694, making the rounded part of the cup.

After reaching the top of the cup in November 2023, the price dipped a bit (this is the 'handle') and stayed around 140.273 until December 2023. During this time, not many people were buying or selling, meaning it was resting. In May 2024, the price finally broke above a key point (149.694), with more people trading, showing that it was ready to go up. After this breakout, the price climbed up to about 161.857 by June 2024.

Final thoughts

• The Cup and Handle pattern is a way for traders to spot trends that look like a cup with a handle.
• The bottom part called 'the cup' is where prices drop and then rise back up, and 'the handle' is a smaller dip after that.
• If the price breaks out from the Handle, it's a good sign that prices might keep rising or bullish, but if the price falls below the bottom of the Cup, it could mean prices will go down.
• Traders use this pattern to help decide when to buy or sell. Here is how to reduce the financial risks: look at specific points (support and resistance levels) to set limits on how much you're willing to lose (stop-loss) or how much profit you want to take (take-profit).