The cup and handle strategy for stocks is one of my favorites. The strategy captures consistent and often explosive price moves/profits. The pattern is easy to find and trade, although there are some very specific traits you will want to look for. Without those traits present, you’ll have a lot more losing trades.
I use this strategy often, especially when the major indexes (like the S&P 500, Nasdaq 100, Dow Jones Industrial) are near prior highs or heading that way.
In the charts below I have picked a few good examples of the pattern, and highlighted some of the traits we are looking for in a cup and handle stock.
The Basic Cup and Handle Pattern
The pattern starts out with up an uptrend.
Then there is a drop.
After the drop the price levels off and starts to rise again.
The price then chops around, forming a sideways triangle pattern or a shallow descending channel. This is the handle. This typically occurs near the high point (which occurred before the drop), but the handle may also occur below or above this point.
In order for me to consider a cup and handle trade, I want to see the handle contract. It starts out as choppy and wild looking and then it settles down. Once it settles down, that is when I get really interested. We’ll get to how I trade these patterns in a little bit.
Charts from TradingView.
In the pattern above, and some of the examples, the stock fell by about 60% and then quickly recovered (the “cup”). During this particular time period, this happened to a lot of stocks. So it was not out of context for the market at the time. And it recovered quickly, so to me that shows strength.
This is more of a V-shaped cup than a U-shaped or saucer cup. I am fine with trading all these types of cup and handles.
While the price has already moved a lot, the cup and handle pattern attempts to capture upside movement following an upside breakout from the handle. There is often still a lot of upside left.
While handles can take many forms, I prefer when they take on a triangle structure with the following features:
- Overall uptrend.
- Price pulls back (downswing 1)
- Price rallies but can only reach the prior high or lower (no new highs, or only very marginal)
- Another price drop (downswing 2)
- Price moves up again and forms a consolidation in the middle to upper portion of the triangle (which we can now draw). If the consolidation is taking up most of the triangle, which is now quite narrow, that is also fine. The consolidation can also form just above the top line of your triangle.
- A consolidation is three bars or more where the price moves sideways.
- Volume ideally drops off during the consolidation or at least has one or more really low volume days (especially on days where the stock drops). Don’t want volume increasing on the consolidation.
- A consolidation is three bars or more where the price moves sideways.
- Price breaks above the consolidation to trigger a long trade.
There are other types of handles as well. But the point is that you need to define exactly how the handle will look, and at what point you will trade it. The price can be quite choppy while forming a handle, so if you don’t have precise rules, you will have more losing trades.
Cup and Handle Strategy Variations
There are three variations of the cup and handle strategy: half-cup, full cup, above cup.
- A half-cup is when the handle occurs in the upper half of the cup but below the prior high.
- A full cup is when the handle forms near the prior high.
- Above cup is when the price blows through the prior high and then forms its first handle a bit above the prior high.
They are all fine to trade, but they just look a bit different.
Cup and Handle Price Targets and Stop Losses
Targets are typically about 20% to 30% above the entry price, or about 3 or 4:1 reward risk. This will vary by stock.
For some stocks, I expect a lot more out of them because they have a lot of momentum. Look through the price history and see how much the price ran after similar patterns. You could also look at prior upswings. If the price has been running up by 50% before having a significant correction on the last few price swings, then use a 40% price target (a bit less than normal), for example.
A trailing stop loss is also effective with this strategy. ATR Stops on TradingView is good. Calibrate it to each stock traded by looking at prior setups on the chart and adjusting the settings so it performs how you want on those. Hopefully, it will perform the same way in the future.
At the time of the trade, a stop loss is placed below the recent consolidation. When the price breaks out of the consolidation we are buying, so if it drops back below the consolidation (after breaking higher) we get out. Note that the consolidation is often a lot smaller than the entire handle.
I use daily charts for setting my profit targets, entries, and stop losses.
Cup and Handle Stock Strategy Order Types
Place a buy stop limit order a few cents above the consolidation to go long when the price moves above the consolidation (which is near the upper portion of the handle usually). This order is set prior to the breakout, but after the consolidation has formed.
The buy stop portion of the order triggers a buy when the price moves up to a certain price.
The limit portion controls the price paid in case there is gap higher or very little volume until a much higher price.
Instead of using a buy stop limit order, you may also have a watch list and just enter when you see a breakout. Or, you can wait for the breakout and then enter near the close of the day (or next day) if it was a strong breakout with a nice volume increase. The stop loss goes below the low of the breakout day with that last approach.
For more on order types and what to do in various situations, such as a price gap, see Navigating Stock Price Gaps with Order Types, Information, and Strategy.
How to Find Cup and Handle Strategy Stocks?
Any scan that looks for stocks with recent upward momentum should be able to find these patterns. Then, manually go through the results looking for the pattern and specific traits discussed.
Manual filter down the results to the best trade candidate(s) with the highest reward:risk and nicest set up based on your research on each stock.
You will know your potential reward:risk before the trade because for every trade you will know your entry price (based on consolidation high), your stop loss price (based on consolidation low), and your target price (estimated based on prior price movements).
Here is a scan that I run on StockRover. Feel free to tweak any of the settings as needed.
The above scan is useful if the S&P 500 or Nasdaq 100 is near its 52-week high. If it isn’t, then adjust the “Price vs 52-week high %>90” down to >70, for example, if the S&P 500 is 20% to 40% below its highs.
Here is another example of a scan I may run when the S&P 500 is within about 15% of its highs. This one is a little looser in that it still finds stocks that are further off their highs (half cups) and maybe have been moving sideways for a while (no 1-month return criteria). Instead, some longer-term strength criteria are added in, such as stocks need to be strong in their own sector (amongst competitors and others in the same general field).
This scan tends to eliminate tiny companies because of the $5 price criteria and the volume criteria. There can be some lucrative trades in tiny companies that are starting to boom. To catch those, allow lower volume and lower the stock price minumum.
The point is simply to find stocks that are performing better than average (the indexes), and eliminate stocks from the list that aren’t strong.
There is an entire article and video on How to Scan for Cup and Handle Patterns and Continuation Patterns using both StockRover and ChartMill which have free versions of their scanning software.
Cup and Handle Chart Strategy Examples
The first chart below is a half cup. It forms a handle in the upper portion of the cup but below the prior high. Once the price starts forming a handle (volatility contraction) we wait for a consolidation (drawn box). Ideally, volume also contracts/drops during the consolidation. We then trade a breakout of the consolidation with a stop loss below the consolidation low (drawn box).
Below is another example of a half cup pattern.
The chart below is a full cup pattern as the handle forms near the prior high.
I have also shown the stop loss, entry, and profit target via the green and red boxes. The red box represents the risk (6.5%), which is the difference between the entry point and stop loss. The green box represents the profit target 22.7%, which is about 3.5x the amount risked.
The prior moves, as marked, helped provide a conservative estimate for a profit target.
A continuation pattern is another trade opportunity to watch for. It is when a handle forms, as described above, but within the context of a big strong uptrend (no cup required).
Cup and Handle Video
Keep in mind that there are lots of handle types. This article describes one type, the video includes some that some slight variations. Yet we want to avoid getting in too early. That is also discussed in the video. Let the price make a couple of swings. Let it contract. Wait for the consolidation, in the proper spot, and wait for volume to drop off before considering an entry.
Getting in too early is probably one of the most common problems I see, and it results in getting stopped out, unnecessarily, often one or two times before the actual big breakout occurs. And those losing trades can easily ruin the profitability of the strategy.
Your position size is how much stock you buy. Your position is not random, or based on how strongly you feel about a trade or stock. It is based on the difference between your entry and stop loss, your risk tolerance, and the amount of capital you have.
No strategy is complete without understanding position sizing, so check out the How Much Stock to Buy article for a full explanation.
CONTEXT: When to Trade Cup and Handles
Context is critical. I want to buy cup and handle breakouts when general market conditions are favorable. That means most stocks are moving up. It is so much easier to make money that way. If most stocks are dropping, many of the cup and handle patterns that do breakout will fail to reach the profit target.
Here are a few ways to assess if the general market conditions are favorable for trading: When to Buy Stocks After a Stock Market Correction. The scanning process is also vitally important. If you aren’t seeing many valid patterns to trade, that means fewer trades in the account, which means you will be holding more cash. Lots of opportunities means more trades and less cash. When the market is not in good shape, we tend to get fewer trade signals. Trust that.
Specific Cup and Handle Traits to Look For
Look for a high point, a drop, and then a rally back toward the high. Ideally, there are two drops, with the second smaller than the first.
A handle can form anywhere between mid-cup and above cup (prior high).
Wait for volatility to contract during the handle, and volume should drop during the consolidation. A tight consolidation will reduce the risk, and volume often (not always) drops significantly just before a big price move higher.
Look for this pattern in strong stocks! Notice in the scan above I am only looking at stocks that have outperformed the S&P 500 by more than 25%. Also, all these stocks are above there 50-day moving averages (in scan).
Want another strategy? Check out the Trend Channels Stock Trading Strategy.
By Cory Mitchell, CMT
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.