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Anatomy of A Cup-with-Handle Chart Pattern

The cup-with-handle chart pattern has four stages: 1) Setup where the stock rises forming the left cup, 2) Decline where the stock collapses forming the base, 3) Recovery where the stock climbs the right side of the cup, and 4) Consolidation where the stock forms the handle. For a pattern to be valid, each stage must meet specific criteria like a minimum 30% gain for the setup, collapse no more than 60% of the left cup price, and handle no longer than 1/3 the cup length. The example of BOOM stock showed a valid cup-with-handle pattern that resulted in a 164% gain after breaking out of the pattern.

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485 views3 pages

Anatomy of A Cup-with-Handle Chart Pattern

The cup-with-handle chart pattern has four stages: 1) Setup where the stock rises forming the left cup, 2) Decline where the stock collapses forming the base, 3) Recovery where the stock climbs the right side of the cup, and 4) Consolidation where the stock forms the handle. For a pattern to be valid, each stage must meet specific criteria like a minimum 30% gain for the setup, collapse no more than 60% of the left cup price, and handle no longer than 1/3 the cup length. The example of BOOM stock showed a valid cup-with-handle pattern that resulted in a 164% gain after breaking out of the pattern.

Uploaded by

bengaltiger
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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9/5/22, 4:27 PM Anatomy of a Cup-with-Handle Chart Pattern

Anatomy of a Cup-with-Handle Chart Pattern


This article considers why a cup with handle forms, the desirable
features of the pattern and how we select them. We will also look at an
example
of one of the best performing cup-with-handle formations recently.

Stage 1: Setup. The pattern starts with


a stock rising from a former base. At some point, profit taking sets-in and
the stock begins
to decline,
ending
the setup. The maximum price reached at the end of Stage 1 is called the 'Left
Cup', and the amount by which the stock rose from its
prior low is the Setup
Gain. To ensure a well-defined left cup, we require that the setup
gain be at least 30% from the prior low level for it to
qualify as a valid
left
cup.

Stage 2: Decline. The stock now collapses


into a new base. The collapse can occur for any number of reasons: poor
company results; over-
all market conditions; bad news; profit taking after
a strong setup stage, and so on. There should be strong selling and volume
should be well
above average for the first
few
days of the collapse.
Note that collapsing price alone is not sufficient to provide a good CwH pattern,
volume is
also important. This is because we want most of the buyers from the
setup stage to liquidate their holdings,
so there
will
not
be a lot
of
overhead
supply
when
the stock
begins
to climb the right side of the cup. The combined price and volume action in
stage 2 is important if the
eventual breakout is to succeed. By the end of
stage 2, volume should have fallen to well below average levels as most holders
have sold and
there is little buying activity, if any. The depth of the base
is important also. We do not want the stock to collapse to a level from which
recovery
will be difficult, if not impossible, so when selecting CwH stocks
for our watchlist we limit the cup depth to be at most 60% of the left cup
price.

Stage 3: Recovery. If and when the conditions


that brought about the stage 2 collapse have been resolved, the stock may begin
to recover. If
it does so, the stock will start to climb the right side of
the cup. As it does so, we like to see above average volume on days when the
price
moves up, which indicates that institutions are taking an interest in
the
stock,
but
light volume on days when it closes down, indicating that
there are small numbers
of sellers. Ideally, this constructive price and volume action will strengthen
as the right side of the cup is formed and
the stock moves higher. Meanwhile,
there will be some holders of the stock who bought at or near the left cup
price but didn't sell in stage 2.
These holders are waiting for the time when
they can recoup some or all of their losses. There will also be profit taking
by bottom-fishers. As
losses are covered or profits are taken there will be
pauses in the recovery and a typical cup right-side will
exhibit
a
stair-step
characteristic,
rather than the smooth ascension shown in the idealized chart. Each of these
pauses, or pullbacks, reduces the overhead supply left over from
the left cup
setup.

As the price on the right side approaches the left cup level, the last holders
will finally decide to cut their losses and there will be a large
volume sell-off.
This often is preceded by a day on which the price spikes on high volume which
the sellers have interpreted as an overbought
condition and therefore a last
opportunity to recoup their losses. This is the point at which the pivot forms,
and marks the end of the recovery
stage.

There are several technical conditions that must be met before our algorithm
will recognize a valid pivot. Firstly we want the stock to have
attained a
strong relative strength when compared to all other stocks, so we require
an RS of 70 on a scale from 1-99. We also want the pivot
to be approaching
the left cup level, so we require the pivot price to be at least 60% of the
left
cup. Thirdly, there must have been sufficient
time for a shakeout of holders
during stage 2, and sufficient time for institutions to notice and take an
interest in the stock during stage 3. This
is essential if the stock is to
be projected to new highs after the breakout. Consequently, we require the
distance from the left cup to the pivot,
to be at least 6 weeks (30 sessions).
On the other hand, we don't want the cup to be so long as to be meaningless,
so there is a maximum cup
length of 325 sessions imposed. A complete list of
our criteria is provided at the end of this article.

We mentioned above the need for constructive price/volume action while the
stock is building the right side of its cup. This is measured by our
Right
Cup Quality indicator (RCQ) and is a component of our overall Chart Quality
metric (CQ). CQ is described here.

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9/5/22, 4:27 PM Anatomy of a Cup-with-Handle Chart Pattern
Stage 4: Consolidation. After the pivot we want and expect
to see a shakeout while the overhead supply is depleted. This will cause the
price
to decline,
initially on high volume but then the price should stabilize or drift down
on volume well below average levels. The institutions who
are tracking
the stock
know that they want the overhead supply eliminated and will wait for these
stable conditions to materialize before they
pounce. To identify well behaved
handles, we require that the decline (or 'droop') in the handle should not
be more than 30% of the pivot price,
that the mid-point of the handle be above
the mid-point of the base and that the minimum time spent in the handle should
be two days, but that
the overall handle length should not be more than 90
days. We also do not want the handle to be disproprtionate to the cup, so we
require that
the handle be no longer than a third of the cup length. The two
day handle
minimum is quite short but we want to make sure we don't miss any
strong candidates
(as will be seen shortly). We give our subscribers the ability to filter out
short handles if they wish.

We measure the price/volume action in the handle using a proprietary metric


called Handle Quality (HQ), which is also a component of CQ,
mentioned earlier.

After the price has stabilized, it is not uncommon to see the price begin
to rise on higher volume. This is an indication that institutions are
starting
to nibble and may indicate a strong breakout to come. We have noticed that
breakouts are 17% stronger, on average, when the price
and volume rise on the
day before the breakout. See our newsletter
of 4/23/05.

When the conditions described in these 4 stages are satisfied, we have a valid
CwH pattern and the stock will be placed on our CwH watchlist,
CwHWatch. If
the conditions change so the stock no longer meets the criteria, then the stock
will be dropped
from CwHWatch. We monitor the
stock while it is on CwH Watch and issue a real-time
alert if the pivot price is met or exceeded and the projected daily volume
exceeded 1.5
times the average daily volume - an indication that institutions
are buying the stock in large quantities.

A CwH Example: Boom

On November 12, 2004, Dynamic Materials reported earnings of 16 cents a share


compared to a loss of 13 cents a share for the same quarter
a year earlier,
and predicted strong future earnings based on order backlogs (see
story). The stock went from $3.66 to $17.58 (a 380% gain) in
the next 8
sessions, completing its stage 1 setup. The stock then entered the stage 2
decline as profit taking took over and after one failed
recovery attempt the
stock lost almost 50% of its value. At its low, volume was well below the average
and had almost returned to the pre-
November12 levels. The recovery then began
with constructive price/volume action as needed. As price and volume picked
up, the stock
formed a low handle with pivot at 13.73. The mid-point of this
handle was below
the
mid-point
of
the
base,
however,
so it did not qualify for our
CwHWatch. A valid pivot did form on Feb. 15 at
14.75 with positive HQ and RCQ values and our Expected Gain model predicted
a gain of 66%
if the stock broke out. On February 18 the stock indicated it
was ready to move higher when it closed at its high of the day.
After the long
weekend it gapped up at the open by more than $2 and broke
out on nearly 8 times average daily volume. It formed a second short handle
and
broke out again on 2/25 on 10 times average daily volume and went on to gain
164% in the next month.

Cup-with-Handle Chart for BOOM as of 02/18/05

Cup-with Handle Chart for BOOM as of 5/12/05 showing progress since breakout.

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