How to Read (and Benefit from) Cup and Handle Formation

Meir Barak |
X_Cup_Chart_II.jpg

The cup & handle formation is a bullish pattern that suggests the shape of a cup and handle. The pattern is comprised of a stock reaching its high, encountering resistance and correcting downwards.  The stock returns to the high, and in this way forms the cup. At the high, the stock once again encounters resistance (remember when we learned the term “double top”?) and corrects downward again while creating the shape of the handle.  This time, when it returns to a high for the third time, it breaks through the resistance and rises to a new high. The breakout point is the point where we should buy the stock.

What have we learned about the stock prior to its breakout? The stock reached a high, so we realize it is strong. It corrected downwards but returned to the same high, from which we learn that buyers are still in control. The stock drops again, but this time drops less than the previous time and for a shorter period. The stock returns to its high a third time.

Conclusion: Buyers are in control, and might even become more aggressive: they are buying after the smallest correction, and they are buying faster. Buyers have begun to overtake the sellers. We conclude that the stock is strengthening and may break out the resistance soon.

Cup and Handle Formation, United States Steel – X

X_Cup_and_Handle__Chart.jpg

In the intraday chart for X, we can see that the stock is rising strongly at the start of trading and meets resistance at the price of $54.49. It retreats, drops [1] but returns again to the resistance point, and in this way forms the cup. Now it drops to a new low [1], which shapes the handle, but this time the low is higher than the previous low, since buyers are becoming more aggressive. It returns to its high again within a shorter timeframe than when forming the cup. The stock breaks through the resistance [2] and climbs to a new high.

Interestingly, if you track back slightly into the previous trading day, you can see that the area of resistance was formed on that day. You can also see that if you connect the previous trading day’s formation to that of the breakout day, you will find a more complex formation called head and shoulder formation, which we will study later. Note that the formation does not need to be perfect from the graphical perspective. For example, the line of resistance does not have to pass exactly through the same previous high points.

To learn more about the stock market and to begin your own journey toward financial independence, visit Meir Barak's site Tradenet and check out his book "The Market Whisperer."  

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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