Cup and Handle Trading Strategy
The cup and handle is one of my favourite trading strategies because if you miss the advance during the cup formation, you can always catch a bullish set up on the handle consolidation before the breakout. I know that this may sound like Greek to some of you but stay with me. I’ll try and make it easy for everyone to understand.
Cup and handle is a bullish continuation pattern that marks a consolidation period followed by a breakout. What am I saying in layman’s terms? When the market dips and bounces back at support level, it will start going up (the advance) forming a cup formation. After the advance the market will pull back (or retrace). As the cup is completed, a trading range develops on the right hand side and the handle is formed. And after the handle is completed the market will then breakout into a strong bullish phase. That’s essentially what a cup and handle pattern is. The pattern actually looks like a cup or a bowl with a handle. This is what it looks like:
For more experienced traders, the cup and handle trading strategy works best if you use Fibonacci retracements because you’ll be able to ascertain if the formation is really a cup and handle or not. Essentially what Fibonacci retracements do is that they help you to see significant levels of support and resistance in the market. A typical cup and handle will normally retrace to the 50.00% or 61.80% retracement levels and sometimes it can even retrace to the 78.20% retracement level. A cup and handle will not retrace to the 100.00% retracement level. If it retraces back to the 100.00% retracement level then it doesn’t qualify as a cup and handle. Bear in mind that it can even retrace to the 38.20% level but the most powerful bullish moves are found when the market retraces to the 50.00% and 61.80% retracement levels.
See the chart below of the Alsi 40. The chart below is exactly the same as the chart above but with Fibonacci retracements included. In this example, the handle retraced to the 61.80% retracement level and look at the powerful breakout that followed.
For long term investors, the cup and handle works even better on higher time frames. See the Daily chart below of Lonmin PLC SA (LON). The stock created a cup formation for months before the handle formed.
When you apply Fibonacci retracements to the Daily chart on Lonmin PLC SA (LON), see how price found support at the 61.80% retracement level before the breakout.
So there you go. That’s how a cup and handle trading strategy works. Hope this will help you in refining your trading and investment strategy.
Note: The 78.20% retracement level doesn’t appear on the charts in these examples but you have the option to insert it on most trading packages when you draw in your retracement levels.