Now that I have set a foundation for what I do, how I trade, and my stock analysis I will be posting trading strategies to help new traders develop a style of their own with both entry, exit and risk. One of my favorite chart patterns that I often recognize is the cup and handle breakout.
This pattern is often called a bullish continuation pattern that will lead to consolidation after a breakout. In this pattern, you will notice two distinct zones implied in the name: Cup & Handle. The cup will form as the stock creates an almost rounded bottom from a breakdown and rise back up.
This example is from $JNUG in mid-December of 2016 leading into January. You can see that there is a falloff in price and consolidation along the bottom, forming a round bottom on the 4-hour chart. After several days of trading down in a consolidation zone, the price starts to climb higher up to the point where the price matches where it was prior to the breakdown. That is the completion of the rounded bottom cup.
This essentially will cause investors to start taking profits, sell off if they had been holding since before the drop off in price, or because they see this level as a resistance area that wasn’t held before. This pullback that will follow the high of the cup forms the handle. The handle represents the last consolidation before the continuation or breakout occurs, retracing back up to higher zones. Ideally, with volume building at the consolidation area, investors will buy in, driving the prices up to breakout levels.
Trading the cup and handle is tricky to do properly. You want to put in buy orders so that you enter just above the upper trend / resistance line created by the ending of the handle. You want to be sure that a breakout is occurring, not just a false breakout that will spike only to cause a massive sell off. Upon entering, you want to watch your position closely, any pullback from your price to under the
support of the handle will see a decline is share price.
In this chart, I have used the same exact chart as posted before only highlighting the points I was making. You can see at $26.00 there is a consolidation zone prior to the drop forming the cup and handle. As the price rises back up to its previous levels, there is a small pullback. As you see a pullback from that level, you want to put your buy order in just above. In this case I have circled where an ideal entry would be for both profit potential and risk mitigation. I would put a purchase order in for $26.50. This shows me that there is a clear break over the consolidation level as well as the upper zone of the final part of the cup and handle.
If the stock continues to rise you are looking at a breakout. If the price fails to trend up and you see a lengthy consolidation around the handle or a continual decline I share value, you will see there is no breakout occurring and no entry should be made. If the price continues towards where I marked X, rather than breakout and run up to where you would have placed your order at, move on to the next stock.
There is often “fake out breakouts” which occur when volume pours into the stock temporarily, driving the price up short term but leading to a sell off once the volume subsides. This can cause you to buy in at your perfect target entry, but see a pullback in share price. I have marked an X that symbolizes where an exit should be made if a fake breakout occurs. The retrace back to support levels of the handle shows lack of sentiment and value by the market at that time, likely leading to a bigger sell off.
This strategy works on any time frame. This example is run off on the 4-hour chart, my favorite time frame to trade personally. If you are a longer-term trader you can use the daily or weekly chart to discover the same pattern on different scales, as well as if you are a day trader or scalper using the 1 minute or 5-minute charts. This strategy is scalable and very easy to recognize and follow. I can answer more questions if there are any regarding this strategy and its application.