How to Identify Cup and Handle Pattern in Forex Trading

The Cup and Handle Pattern provides traders with ideal entry or buy signals in a market during an uptrend.

In this article, we discuss everything about the Cup and Handle Pattern and the related strategies that one can apply while trading.

*This is an example only to enhance a consumer's understanding of the strategy being described above and is not to be taken as Blueberry providing personal advice.

What is the Cup and Handle Pattern?

The Cup and Handle Pattern is a technical price chart that forms the shape of a Cup and a Handle, which indicates a bullish reversal signal. It helps traders find long opportunities in the market as it is formed during a continued uptrend. This pattern appears when selling pressures exceed the buying pressures, which results in a temporary and weak downtrend followed by a stronger uptrend.

• The shape of the Cup in this pattern resembles a 'U', and the longer the 'U', the stronger is the trend signal
• The Handle takes the shape of a declining linear trend.
• Traders receive a buy signal at the bottom or end of the Handle as the prices incline thereafter.
• Traders receive a stop-loss order placement signal at the end of the Handle's low point breakout level.

Example of using the Cup and Handle Pattern

When forex trading, let’s assume,you decide to enter a USD/EUR trade at the exchange rate of 2, during an uptrend. The exchange rate reaches a high of 4.5, where you decide to exit the trade and lock in the profits.

Now, the USD/EUR price starts falling from 4.5 to 3, and then 2.5. Thereafter, the currency pair trades around the same 2.5 level for some time before witnessing an uptrend once again.

The uptrend raises the USD/EUR prices to 4.4, which is very close to the previous high price of 4.5. At this point, a U shaped Cup forms, signaling a possibility of the Cup and Handle Pattern formation.

A temporary downtrend then replaces the uptrend as USD/EUR prices start falling again and reach a level of 2.7, another low. This forms the Handle of the Cup and Handle Pattern, confirming the bullish reversal pattern.

At this point, traders receive a buy signal to place long orders at the exchange rate of 2.7, as the USD/EUR prices start inclining for one last time, forming a continuous uptrend and reaching an exchange level above the previous high of 4.5. You can stay in the trade for as long as the market trades in your favored direction.

The stop-loss order can be placed around 2.7 to ensure that your risk and losses are protected if the markets turn against you.

Identifying the Cup and Handle Pattern

The cup and handle pattern is a technical analysis chart pattern that suggests a potential reversal from a downtrend to an uptrend. It consists of two main components –

1. The cup

• U-shaped formation: The cup resembles a U-shaped formation, indicating a period of consolidation or accumulation.
• Depth: The depth of the cup can vary, but it is typically at least half the size of the preceding uptrend.
• Rounding bottom: The bottom of the cup should be rounded rather than sharp or angular.

2. The handle

• Short-term downtrend: The handle is a short-term downtrend that forms after the cup.
• Consolidation: It represents a period of consolidation or profit-taking before a renewed uptrend
• Angle: The handle should have a downward slope but should not be too steep.

Types of Cup and Handle Pattern

1. Inverted Cup and Handle

The Inverted Cup and Handle pattern is the exact opposite of the Cup and Handle Pattern as it indicates a bearish reversal pattern. It provides traders with ideal sell/exit signals and also enables them to short trades during the downtrend. Being the opposite of a regular Cup and Handle Pattern, it first makes an 'n' shape (Cup), followed by an upward linear shape (Handle).

In this pattern, asset prices first witness a steep fall during a continued downtrend, followed by a sudden but not so steep increase in the prices. The prices continue trading around the same range before finally falling again, making the first half often pattern – the inverted Cup.

After that, the prices temporarily start increasing again, making the second half of the pattern – the Handle. The temporary incline in prices is followed by a continued downtrend thereafter, reversing the market into a bearish trend.

• Traders receive signals to short, exit or sell the trade in this pattern at the topmost point of the Handle.
• The stop-loss orders can be placed at the bottom of the commencement of the Handle.
  
  

2. Cup and Odd Handle

The Cup and Odd Handle Pattern include a less rounded bottom that makes the Cup look like a 'V' shape and an odd-looking non-linear line signifying the Handle. The Handle is not more than one-fourth of the Cup's total length and does not look like the regular Handle. However, the Handle still serves the same purpose as it indicates a temporary decrease in the prices. It provides the trader with an ideal buy signal to long the trades. The pattern occurs in a continued downtrend, witnessing a steep fall in the prices, reaching a new low and following a sharp increase thereafter. This incline is followed by another temporary (and short) fall in the prices, followed by a continued uptrend.

3. Multi-year Cup Handle

As the name suggests, the Multi-year Cup Handle is formed over a few years in the financial market. The initial steep drop in the prices followed by an incline forms the Cup in the pattern, which is more like a 'V' shape and less like a 'U' shape followed by constant fall in prices that make the Handle. It comes with a regular pullback expectation, but the prices witness a temporary decline over a few months to a year before they rise back again. The final increase in prices provides traders with entry signals in the market. The Multi-year Cup Handle best suits traders who want to trade in the long-term and look for historical price patterns to make trade decisions accordingly. It provides traders with the continuous trend existing over the years and signals them the ideal long opportunities.

4. Intraday Cup and Handle

The Intraday Cup and Handle pattern is a short term pattern that can be located on a 60-minutes chart and help traders long for a trade opportunity in a continuous trend. It looks almost the same as a regular Cup and Handle with only one difference - since it appears on an hourly chart, the price fluctuations are higher but close to each other. So there are more price moves in the charts, making the pattern appear narrower. It is identified in an uptrend when prices start dropping temporarily, trade within a range for some time before rising back up, forming a flat 'U' shaped Cup. The formation is followed by some decrease in the prices, forming the Handle, followed by the final uptrend.

How to trade with the cup and handle pattern

1. Identify the pattern

First, look for the cup on the price chart. It should occur as a U-shaped formation, indicating a consolidation or accumulation period. Next, the trader must spot the handle that follows the cup when a short-term downtrend occurs, representing a period of profit-taking.

2. Confirm the pattern
Confirm the pattern based on symmetry. The cup and handle should be roughly symmetrical. There should also be a decrease in volume during the cup and an increase in volume during the handle.

 

3. Wait for the breakout

Identify the resistance level at the top of the handle. Wait for a bullish breakout above this resistance level. Consider entering a long position once the price breaks above the resistance level.

4. Set stop-loss and take-profit

To limit potential losses, place a stop-loss below the handle's low. Additionally, consider using Fibonacci retracements or technical analysis targets to determine potential profit levels.

5. Monitor the market

Finally, look for confirmation signals, such as a series of higher highs and higher lows after the breakout. Be aware of false breakouts, where the price initially moves in the direction of the chart pattern but then reverses. Consider exiting the trade if the price falls below a support level or a bearish technical pattern forms.

Cup and Handle Pattern trading strategies

1. Selling the supply line strategy

The selling the supply line strategy follows trendlines to place profit targets and provides traders with ideal profit levels during a long or short trade. With this strategy, traders receive closer to accurate signals about where the market can potentially reach, set their profit targets accordingly and make trade decisions wisely. Both the high price points on either side of the Cup in the Cup and Handle Pattern are joined with a horizontal line and expect to have a target at a level double of the line's positioning. This means if the line that joins the high price points of the Cup is at an exchange rate of 5, profit targets are set at an exchange rate level of 10.

2. Strong Handle strategy

As already discussed, the shape of the Handle in the Cup and Handle strategy differ according to the time frame and overall market sentiment. In a medium or long-term trend, the Handles are generally not very clearly visible due to the large spread in prices, whereas, in a short-trend, Handles are clearly depicted through a temporary downtrend as they trade in a tight price range. As Handles in this pattern provide traders with ideal stop-loss and buy levels, they are vital as it helps traders minimize their loss possibilities. Trading the strongest Handle provides traders with stop-loss and entry levels that enable traders to make successful trading decisions. Here is how you can trade with the strong Handle strategy as an intraday trader –

• On a 5-minute chart, identify the Handle that is made up of at least four and at most ten candlesticks.
• Make sure that all the candlesticks have a short body and trade in a tight range.
• The downtrend that follows produces a price expansion, providing traders with an opportunity to long the trade.
• The last candlestick in the Handle closes above the resistance level in the market, at which the rising prices stop rising and start falling (temporarily).
• Traders receive the exact buy signal at the level where this Handle ends and prepares to follow a bullish reversal and continued uptrend.

3. Cross of cloud buying strategy

The cross of cloud Cup and Handle buying strategy indicates the breakout level at which traders can long the trades. It provides traders with the ideal entry points in the market that help them place successful buy orders. It consists of a cloud range that tells trades where the asset prices are potentially going to head in the future during the uptrend. When the Cup and Handle pattern's Handle breaks above this cloud, it confirms the strong uptrend and provides traders with an entry signal. However, if the last candlestick in the Handle does not break above the cloud, the traders receive a signal that the pattern might send a false long signal, and they should wait for the uptrend confirmation.

4. The pre-breakout strategy

In most cases, traders trade the breakout in the Cup and Candle strategy as soon as the asset prices break above the Handle formation. With the pre-breakout strategy, traders can actually long a trade well before price actually breaks higher, with a goal of profit maximization. Here is how you can trade with the pre-breakout strategy –

• Identify a Handle formation when the market is not very volatile in a medium or long-term time frame to make use of the Cup and Handle Pattern.
• Now, move to a lower time frame chart to identify a false breakout level near the support level of the pattern, the point where falling prices stop falling and start increasing.
• If you notice a false breakout occurring at or near the support level, place the long or buy order there and then to trade the breakout before it actually occurs in the medium- or long-term time frame.
• You can place the stop-loss order at the low-price level to minimize risk.
  
  

Advantages and risks of the cup and handle pattern

Advantages

• Clear reversal signal: The cup and handle pattern provides a strong visual signal of a potential reversal from a downtrend to an uptrend.
• Measurable targets: Fibonacci retracements and other technical analysis tools can be used to set specific gain targets based on the dimensions of the cup and handle
• Reliable continuation pattern: Once the pattern is confirmed with a breakout, it can indicate a continuation of the uptrend, providing opportunities for further gains.

Risks

• Time-consuming: The formation of a cup and handle pattern can take time, and there's a risk of missing out on potential profits if the pattern takes too long to complete.
• False breakouts: The pattern can give false signals, especially if a sustained uptrend does not follow the breakout.
• Subjectivity: The interpretation of the cup and handle pattern can be subjective, and different traders may have varying opinions on the exact dimensions and characteristics of the pattern.

Stop-loss placement and risk management

Traditional stop-loss placement - below the handle's low: 

Place the stop-loss just below the lowest point of the handle. This ensures the trade is exited if the price reverses back into the handle formation.

Alternative stop-loss placement:

• Based on risk tolerance: Determine the desired risk-to-reward ratio and set the stop-loss accordingly. For example, if a trader wants a 1:2 risk-to-reward ratio, the stop-loss should be twice the distance from the entry point to the nearest support level.
• Using a trailing stop: As the price moves in the trader's favor, consider using a trailing stop to lock in gains while limiting potential losses. This involves setting a stop-loss that moves up with the price, protecting gains.

Risk management tips while trading the cup and handle pattern

• Set a realistic stop-loss: Don't be afraid to set a tight stop-loss to limit potential losses, especially if the pattern is uncertain or the market is volatile.
• Consider the overall market conditions: Evaluate the broader market trend and volatility before entering a trade based on the cup and handle pattern.
• Diversify your portfolio: Don't rely solely on the cup and handle patterns for the trading decisions. Diversify portfolio to manage risk and reduce exposure to any single strategy.
• Continuously monitor the market: Stay updated on news, economic indicators, and other factors that could impact the market and overall trades.

Managing false breakouts

False breakouts are common in technical analysis, including the cup and handle pattern. Here are some strategies to help traders manage false breakouts and improve their trading decisions –

Volume confirmation

A significant increase in volume often accompanies a genuine breakout. If the volume is low during a breakout, it could be a false signal. If the volume decreases after a breakout, it might indicate a potential reversal or a false breakout. 

Price action confirmation

A retest of the broken resistance level often follows a genuine breakout. If the price fails to hold above this level, it could be a sign of a false breakout. After the breakout, a series of higher highs and higher lows can confirm its validity.

Time frame analysis

Consider analyzing the pattern on higher time frames (such as daily and weekly) to get a broader perspective. A breakout that is confirmed on a higher time frame is more likely to be genuine. Traders can also utilize multiple-timeframe analysis to better understand the cup and handle patterns on multiple timeframes together. If the pattern is confirmed on a higher timeframe but not a lower one, it could indicate a potential false breakout.

Trade with the Cup and Handle Pattern to identify bullish reversals

Identify ideal entry points with the help of the Cup and Handle Pattern in the forex market. Start your trading journey Blueberry. to enjoy an end-to-end trading experience with expert brokers and advanced tools and techniques. Sign up for a live trading account or try a demo account on Blueberry.