Use Cup and Handle
To Spot Monster Stocks
The cup and handle pattern is one of the most famous pattern that investors look for. This pattern is popularized by William O'Neil in his book How to make money in stocks.
O'Neil did a study on stocks that made huge gains. From that research, he found that many monster stocks made this pattern before they made huge gains. Today, this pattern is still popular and many have achieve success by following the teachings in O'Neil's book.
The cup and handle pattern looks exactly like what it is called. It resembles a cup with handle. The stock rises to a high and then drops forming a 'U' shape bottom. As the stock reaches the old high it drops and forms the handle. The stock then rises from there and breakout.
This pattern can last from 7 weeks to 65 weeks. However, most will be about 3-6 months.How to trade the cup and handle
Wait for the cup and handle to form. Generally, you will enter the stock once it goes above the second high by 0.10$. At times you will notice that there is no handle. This happens especially when the market moves very fast.
Below are the criterias you should be aware of:
- There must be a prior existing uptrend. There should be at least a 30% increase in price in the prior uptrend. However, The trend should not be too mature. The larger the prior trend, the lower the odds that a big breakout will occur.
- The shape of the cup should be a 'U'. If it is more like a 'V' shape, the reversal is too sharp. It cannot be considered a good consolidation with valid support at the bottom of the 'U'.
- It is good to see equal highs on both side of the cup. But that is not necessary. Sometimes the second high will not reach the old high.
- The ideal depth of the cup should be around 1/3 of the prior uptrend move. Sometimes you will find the stock retracing about 1/2 of the prior uptrend. That can happen in volatile markets. However, historical research has shown that stocks that retrace more than 50% fails to move more than 5%-15% after the breakout.
- The formation of the handle normally takes more than one or two weeks. It usually has a downward price move or shakeout. Look for volume to dry up near the end of the handle. The handle should form in the upper half of the cup. The handle should also be above the 200 day moving average. Otherwise, the stock may be weak and failure prone.
- The price drop in the handle should be within 10%-15% of the peak. During a bear market bottom, some handles can drop 20%-30%. The smaller the retracement, the more bullish and significant the breakout will be.
- At times, the downward move of the handle can resemble a flag or pennant that slopes downward.
- The volume during the breakout should be high. This is a sign that the upward trend will continue and not fail.
- You can project the upward move after the breakout by measuring the distance between the right peak of the cup and the bottom of the cup. Take the distance and project it upwards from the breakout to get an rough estimated target.
- A cup and handle pattern can fail if the stock price falls below the 200 day moving average in the early stages of the pattern formation.
- You can enter the stock once the price rises above the right peak. If you want a safer entry, you can enter once the stock rises above the left peak which is normally higher. As with the other patterns, the stock may come back to test the support after the breakout. Some traders will enter when the stock comes back to the support.
As with the other patterns, the cup and handle only shows us a probable entry area. Do not be too concerned about the particulars. You may find other criterias you want to note down as you become more experienced.
For more information on how to use this pattern to profit, take a look at O'Neil's book, How to make money in stocks. You can also visit O'Neil popular website here.
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