Cup and Handle Chart Pattern Strategy
Hey, traders. Welcome to video 12 of the Advanced Forex Strategies course. This is Cory Mitchell. In this video, we are looking at the cup and handle chart pattern strategy, brought to you by Investoo.com.
So, trend trading is where the money is, as we always say. The cup and handle chart pattern provides a way to get in on the next trending move. Our risk will always be lower than our potential reward. Otherwise, we don’t take the trade. It can be used on all timeframes, but we do want to be aware of what is happening on larger timeframes. Trade in the direction of the trend, which is the direction of our cup and handle breakout, and overall recent momentum.
Cup and handles are a reversal pattern. It can be seen at tops and bottoms. Only trade breakouts higher from a bottoming pattern, and only trade breakouts lower from a topping pattern. With this strategy, we can set and forget. Once we have our entry, we can set our stops, set our target and let math do the work. As indicated, our profits are going to be bigger than our losses. This pattern occurs frequently, depending on how strict you are for the specifications of the trade. I am not very strict. I prefer to take more trades than less, and we’ll show how you can differentiate between being too strict and too lenient.
So, a cup and handle bottoming pattern is created by a move lower followed by a rounded bottom followed by a rally higher to the top with pullback in the downtrend. This creates a cup-like appearance, where similar highs create the lip of the cup. So, maybe just watch my mouse. We are moving down, and then we have a cup shape at the bottom. You can think of it like a long ladle too. So, we just have this cup-like appearance, and you have similar highs at the top of the cup. When we look at a few examples it will become clearer.
So, a pullback lower from the lip of the cup creates a handle. The handle shouldn’t pull back more than 50% of the cup. So, we have this cup here, and a handle. It shouldn’t retrace this whole distance of the cup. Once again, we’ll look at some examples. Traditional analysis tells us the cup must be rounded. I am definitely not a traditionalist. A v-bottom is fine. So, a v-bottom, instead of having a rounded cup, we’re just going to go boom, boom, and to me that actually shows a stronger shift in momentum. I would rather trade that v-bottom.
Buy when the price breaks above the handle. Typically, that would be a trend line break. Stop goes 1 pip below the handle low. Target is the height of the cup. If we’re taking a conservative estimate, add it to the breakout point, or non-conservative, we can add it to the bottom of the handle. Of course, there are always the options to use targets at 1.6, 2.6 and 3.6 times our risk, which is generally what I always do with pretty much every trade I take. I like to get some out very quickly at that 1.6, and then you can let the rest ride. Less than 1% risk on every trade we take.
So, a cup and handle topping pattern is created by a move higher followed by a rounded top, then a decline to the bottom of a pullback in the prior trend. This creates an upside-down cup, and the similar lows create the lip of the cup. So, in this we have an upside-down ladle, moving higher choppily, and then we have the dome-like cup at the top, an upside down cup, and similar lows create the lip of that cup.
So, a pullback higher from the lip creates the handle. The handle shouldn’t pull back more than 50% of the cup. Once again, a v-top is fine. If we go higher and then pull straight back, that’s fine by me. It doesn’t necessarily have to have a rounded appearance.
Sell when the price breaks below the handle. Stop 1 pip above the handle plus the spread. So, whatever your spread is, you’re putting your stop 1 pip above that high, and if you have a 1-pip spread you’d add a pip; if you have a 2-pip spread you’d add 2 pips.
Target is the height of the cup subtracted from the breakout point if we are using a conservative target. We’ve talked about that in prior videos. The difference between being conservative in your estimate is not using extreme prices, stuff like that. Or using a non-conservative, in which case we can just subtract it from the top of the handle because that would give us a conservative estimate. Of course, there’s always the option to exit at 1.6, 2.6, and 3.6 times the risk, which I love as you know. Less than 1% risk on the trade.
So, here we have the NASD/USD. It’s a one-hour chart. Moving lower, we can see and then we get this pattern right here. As we can see, this is more of a v-bottom. It has a slightly rounded appearance, but basically we’re making this. This is what I’m looking at here. We have a similar high, these right here. Let me get rid of this for a second. So, in this downtrend we have this pullback then a move lower, then we have a move higher, which pretty close to matches that last down wave. So, this shows us that momentum has shifted enough to the upside to basically erase that last down wave. So, that’s what we’re looking for. That shows us, all right, we have enough momentum to move higher to erase that last down wave. We could potentially move higher again if we get a breakout of the handle.
So, as this is occurring, once we see this price moving higher, we’re watching this in real time, we’re starting to think, “Okay. If we get a pullback here, and it stays above 50% of this,” I mean, we don’t have to measure exactly, but we can see this isn’t a very big pullback. If it breaks higher I want to get into that. Once again, I do not, as you may have noticed from a number of other videos, I don’t really care about extremes, so the fact that this didn’t quite reach this high I’m not too concerned about. This area that it hit multiple times, one, two, three bars right in here, it was reached by this bar, so that’s fine by me. As long as it’s close, you can see the cup-like appearance here, that’s what we’re looking for.
Then we have this pullback. We want to see at least a few bars. I’m not going to impose a rule on this one simply because sometimes if there’s a lot of strong momentum, we may only get a couple-bar pause, and if we say, “All right, it needs to be four bars or five bars,” we might miss the trade. And I typically do like these types of trades. So, I’m not going to impose a bar limit on it, but you want to have this appearance where you have this cup-like appearance, a pullback, and then you trade the breakout of this.
So, we would be going along, as soon as it breaks this sort of trend line, of course as I mentioned in the prior video, sometimes how you draw these things is going to be a little bit subjective. If you draw it here, you’re going to be entering very quickly here. If you draw it like that, your entry point is going to be a bit different. It doesn’t really matter. In the end, it’s all going to come out in the wash over a great many trades.
So, here, we want to establish our profit target. So, we have our entry there. Our stop goes one pip below this. So, basically we’re looking at a very small risk on this trade. 3.5 to the bottom, we add an extra pip, so we’re looking at 4.5 pips of risk. We don’t have to add the spread because these prices are based on the bid, so our stop will hit the bid and we’ll just take the 4.5 pip loss. So, 1 pip below the bottom.
Establishing our target, we are taking… we can just the trend line tool again. You don’t have to do the math. We’re not using extremes, so this is going to be our conservative target. So, we’re going to go right from there, which is the point here. We’re not going to take the exact extreme low, and we’re going to go from this point where basically we’re looking at the lip of the cup.
So, we have this high. It was hit here, hit here, hit here, so that level’s been used a few times. I’m comfortable using that one, so that is going to be our conservative target, and we can add that to our breakout price, which would have been right about there. So, we didn’t quite get out. We had this nice, strong surge higher. We didn’t quite get out. We would’ve had to wait for this next rally here, but we can see we would’ve eventually got out for a nice gain on the following day.
Now, if you don’t want to think about conservative targets or anything, you can just take the high and the low. So, from that bottom to that high right there, and you can add that to the bottom. And you’re going to get a target roughly in the same area as the last target. In this case, it’s a little bit higher so our target would’ve been there. We still would’ve got out. Basically, all this does is it eliminates all that subjectivity of the height of the pattern, and you’re reducing it a bit by putting it off the bottom of the pattern.
Remember the conservative pattern, we went from our breakout price. Non- conservative target, we put at the bottom. So, this is something you can do with some of the other strategies that we discussed too. If you’re unfamiliar or don’t really feel comfortable coming up with the conservative estimates, you can use this.
Also, you have the option of using the 1.6, 2.6 and 3.6 times our risk. So, in this case, as we mentioned we have a 4.5-pip risk, so you put out targets at 4.5 times 1.6, so 7.2 for our breakout price. So, we would’ve got out somewhere right in about here. 4.5 times 2.6, 11.7 pips. So, that would’ve been somewhere up in here. 11.7 right there, so we would’ve got out right in this area here. And 4.5 times 3.6, 16.2. So, from our breakout price, wouldn’t have got out there, wouldn’t have got out there, so we would have once again had to wait to, we had this wave higher to get out of that trade. But we would have locked in some profit along the way.
So, I do like to do that. That is always an option, and one I encourage. I chose this pattern. It’s a little bit ugly again. As we discussed in the last video, there’s always some subjectivity in trading and it doesn’t really matter exactly how you enter, if it’s going to be one or two pips different. At the end of the day, over a great many trades, it’s not going to really matter. But here we have this move higher, followed by a very ugly cup you could say. We have a sharp move higher; it bottoms out, rounded top, collapses.
We have a cup that the rim of the cup reaches very similar levels, so this shows that this down move has basically erased all of this prior up move, which means we could expect some continued downside. Once again, in real time, as we’re watching this, we will have to determine how we are going to trade it. So, we see this, we see this sharp drop. At this point we’ve got to be saying, “Okay. We have potential for more downside.” We do have a little handle here but no breakout. Then we have this sharp move higher. That hasn’t changed anything. We’re still making a lower low.
We did retrace quite a bit of that handle. This would be about pretty much at the threshold of what I would trade because we’ve retraced probably about 50% of the height of this cup. So, that would be about the extent. If it went any further than this, then we wouldn’t look to trade it. So, then we do have more of a handle here, as we can see. So, we can trade either the breakout of this first handle, which would be this trend line, or we have these two bars, which create another trend line, and we could have traded that breakout there, in which case a stop would have been placed right here above the handle highs because both breakouts occurred on this side.
So, we would’ve known that’s the high, and we would’ve put a stop there, and we’re looking for that continued move lower. In this case, it didn’t come right away. We had to wait for it, but our stop wouldn’t have been triggered.
Establishing a target. Once again, we can see this is more likely the top of the actual pattern. These could have been just a few trades that went through in addition to it. So, this is going to be our conservative target from right about there, top of the pattern not including the extremes, to this low and this low, but not including the extremes. So, this place, this was hit by all four of those bars that we see. This area only hit by one, so we don’t want to use that.
So, this is our conservative target. Add it to the breakout price, and we can see that eventually the price did move down. Although we had some choppy action through here, we did eventually get out at our target. So, that’s our target. We’ll mark it as green. So, if we didn’t want to have to do that, and we just wanted to take the full measure of that cup and handle, or the cup, we can add it to the top of the handle. In that case, this handle is very large so we end up with a slightly smaller target. So, our target would have been there. A similar area again, but basically we’re up. We’re getting out of this. It’s just a different way of calculating it.
As always, we can use the 1.6, 2.6, and 3.6 times our risk. So, we’re entering here. In this case, our stop would have been 14.3 pips plus whatever your spread is. So, if you round that up to 16, then you would be getting out at 16 times 1.6, 16 times 2.6, 16 times 3.6, and you would have been getting out on these waves lower as they occurred with a final target, likely down in this area.
As I said in the slides, we do want to be aware of what is happening on a longer timeframe. This move higher, I like, because we stayed below this low. So, we can see we’re in an overall downtrend, or a longer-term downtrend. So, even though the short-term trend was up and then we saw this reversal pattern, the move to the downtrend was confirmed both by the cup and handle, which we were trading, and also this longer-term trend.
Now on this pattern here, you can see the market is barely making new lows. When we just make a new low and we have this rally higher, it helps us confirm the long as well. We’re moving in this choppy sort of channel. So, when we get that bounce off the lows here, that helps us confirm that there might be some more room to the upside as we move back toward the top of the channel. So, if you recall, if you go back to some of the other videos, trend channel trading, the pocket strategy, all of these can be combined to help you isolate trades which are higher-probability than simply just spotting a pattern and trading it. We can always look for other evidence to help us suggest when a trade is worth taking.
So, both of these ones worked out well. This one occurred near the top of the channel and we had more room to the bottom. This one occurred near the bottom of the channel, and we had some room to profit to the upside.
So, a little review. Every trade has a stop and target. Put these orders out when you place the trade. Risk 1% or less of your account per trade. That way, even a string of losses won’t significantly draw down your account. These take practice to spot and trade. Make sure the lip of the cup is level or close to it, as that shows the market has had enough momentum to offset the last trending wave. You can also look for other evidence using other strategies, other forms of analysis to help pick trades that are likely going to be high-probability. Trade in the direction of the breakout. Place a stop just outside the handle low or high on the opposite side of the breakout. Target is based on the height of the cup.
When being conservative, add it to the breakout point. If we just measure the whole cup, then add it to the bottom of the handle. The same thing goes for a topping pattern, except that we’re going to subtract those targets. Optional, and the method I always use, is get out at 1.6, 2.6 and 3.6 times your risk. So, I’d rather take a couple different positions, the same entry point and get out along the way as opposed to just using one target.
If holding multiple positions, get out one-third at each. Trading involves substantial risk of loss. Only trade with capital you can afford to lose. Test out strategies before using them to make sure you can actually implement them and that they work for you. Once again, you’re going to need to have to go through, find these, spot them in real time and make that decision in real time. “All right, am I going to trade this as it breaks out? Where is my stop going? Where is my target going?” You can have that all calculated out before that entry point even comes. So, until next time, happy trading.