So far, we have seen two different types of bullish continuation but Cup With Handle is again very different and boasts unique features. Firstly, it will rally to a new high before then seeing a significant decline of sometimes up to 50% over numerous weeks. After this, a second rally will bring it just below the previous high level before another decrease (this time up to 20%) over a short time period brings it down once more. Finally, a fresh rally will bring new highs on strong volume.
In this scenario, the eventual breakout section is considered to be the ‘handle’ with the ‘cup’ providing the main bulk of the diagram. By adding these two together, you will soon see the technical target for a cup with handle pattern.
After a powerful stock advance is seen, the cup with handle is normally the corrective action that takes place. Normally, for up to four months a stock can have a powerful move but it will always go through the market correction process. In essence, the stock will sell off for around one-third off the previous high point. In terms of duration, eight to twelve weeks is considered correct but this can change with the condition of the market.
When we see the second high, people who bought the stock at the first high will be under pressure to sell and this will affect the stock price in itself. For around one to three weeks, the price will drift sideways and lean towards decreasing.
In relation to the previous high point, the handle will normally finish around 5% below. If it finishes any lower than this, it will be considered ‘defective’ and there will be a much higher risk of failure. When buying stock, you should try and aim to purchase just as it reaches the new high points right at the top of the handle.
Much like the previous two examples, there are some key techniques and phrases that need to be explained so we have them below. Firstly though, it is important to note that for the new rally to succeed, price action must be supported by volume. According to the O’Neil approach, the breakout volume has to increase 50% above 50-day volume before then reaching the new high. With this in mind, it will look for candidates that participate more on up days than down days. In addition to this, volume action within the cup is also filtered by the definition.
Cup - Much like the shape of a bowl, the cup should be of a ‘U’ shape. If the shape represents more of a ‘V’, the movements are considered too sharp. With slower and softer movements, a ‘U’ shape presents a consolidation pattern with the support coming from the base of the shape. Although this isn't always the case, a perfect cup would have equal lengths on both sides.
Trend - If possible, the trend should have existed previously and have a life of more than a month. If these key requirements are met, it will qualify as a continuation pattern. However, the likelihood of the patten marking a continuation will decrease the more mature the trend becomes. Furthermore, maturity will also decrease the upside potential.
Handle - Normally, the pullback seen after the high forms on the right side of the cup will form the handle. Whilst sometimes it can be a short pullback, other times it can resemble a pennant or flag. Before the big breakout, this handle represents the last pullback. If you wanted to judge the formation, it will be more bullish the smaller the retracement.
Cup Depth - Ultimately, the markets can change the depth of the cup but it shouldn’t retrace over 1/3. In extreme circumstances, it is possible to see a retracement of 2/3 but this is rare and is explained by Dow Theory.
Volume - Above the handle’s resistance on the breakout, you should see a significant increase in the amount of volume.
Duration - Overall, the cup and handle take different amounts of time to form. Although the handle can be complete within four weeks, the cup can take anywhere up to six months.
Target - By measuring the distance between the bottom of the cup and the right peak, the advance after breakout can be predicted.