Cup and handle is a bullish continuation pattern. These basic rules to analyze cup and handle pattern can help you to understand its viability.
This unique pattern can easily be compared with the typical shape of a tea cup. It was originally introduced by William O’Neil. The cup with handle pattern is usually preceded by an upward move that stalls due to selling off.
This initial selling pressure results in the formation of initial part of this pattern. After the sell-off, the security is likely to trade flat for an extended period of time without any clear trend.
In next part of the pattern, an upward move will proceed back towards the peak of the preceding upward move. Finally, the last part of the pattern i.e. handle formation is marked by a relatively smaller downward move.
This move is followed by a bullish breakout with increased trading volume & volatility. But, cup with handle pattern is not as easy as it may appear to novice traders. You need to follow certain basic rules to identify and trade this pattern. Here are 20 simple rules or guidelines to investigate & trade cup and handle pattern in technical charts:
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(1) Larger & Older The Prior Trend, Lower The Potential For Large Breakout After Pattern Completion
It is one of the most significant rules to analyze cup and handle pattern. Cup with handle is a dynamic chart pattern that needs to be analyzed from wide range of aspects.
First, it’s important that there is a prevailing upward trend before its formation. Ideally, a cup with handle pattern should always be formed between 1/3rd and 2/3rd of the previous uptrend.
It usually depends on the prevailing overall market volatility at the time of formation of chart pattern. In general, if a prior trend is larger & older then the potential for a large breakout after pattern completion diminishes.
It is perhaps due to the fact that a lot of run-up in the security has already happened prior to cup formation. It weakens the potential upward move. Therefore, nothing is left to move the price of instrument (stocks or bonds or currencies) towards higher levels even after breakout.
On the other hand, if the prevailing trend is much older in terms of its age then it is likely to diminish the potential upside after final breakout.
Additionally, if the overall markets are in correction mode or in a bear market then also the pattern is likely to fail. Therefore, the length & age of prior trend gains significance in analyzing the potential of the cup with handle pattern.
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