The Cup and Handle Pattern: A Comprehensive Guide for UK Traders

As buyers and sellers execute orders in the financial markets, it can sometimes lead to repeated patterns of price behaviour. One of these patterns is known as the cup and handle pattern which can be identified on different asset classes including stocks and shares, foreign exchange and commodities.  

William J. O'Neil first identified the cup and handle pattern in his 1988 book called How to Make Money in Stocks. In this comprehensive guide, we cover how to identify the pattern, its use in bull and bear markets, potential entry and exit points and the common mistakes to avoid. 

Understanding the Cup and Handle Pattern 

In this section, we cover the core concepts of the cup and handle pattern including its key characteristics.

Formation and Definition 

The cup and handle pattern is a bullish continuation pattern that highlights a period of consolidation, followed by a price breakout. There are two parts to the chart pattern: the cup and the handle.

The formation of a cup and handle pattern is relatively simple. The cup formation represents a rounding and bottoming formation of price, that rallies all the way back to the top of the cup, known as resistance. This is a bullish sign as the sellers who initially drove the market lower have not managed to continue the move, allowing buyers to drive the price all the way back to where it started.

At this point, price action is now considered to be neutral. Sellers may not be keen on trying to sell the market again. But the buyers may hesitate to buy just in case the sellers do turn up at the resistance level again, as they did so before.  Subsequently, the market goes through a period of consolidation.  

This consolidation period is known as the handle. A successful completion of the cup and handle pattern is when the price breaks through the top of the cup at resistance. The breakout now consists of two significant events.

First, the buyers willing to continue the move higher, as they did from the recent upmove in the cup formation. Second, the remaining sellers exiting their short positions, realising buyers are taking control. To exit a short position, traders need to buy their positions back in the market. Learn more about short selling in the What is Short Selling Guide.

As the breakout consists of many market participants buying the market, the cup and handle is defined as a bullish continuation pattern.

Key Characteristics 

There are some key characteristics that a cup and handle pattern must conform to.  

1. The handle must be smaller than the cup and should ideally only retrace to within the upper third of the cup. 
2. The cup must represent a U-shape like a bowl. A V-shaped bottom represents a sharper reversal signifying a reactionary price movement rather than a building of price movement. 
3. It is more ideal if the handle forms another type of consolidation-based technical analysis chart pattern such as a flag pattern or pennant, but a simple pullback is sufficient. 
4. As the cup and handle is a bullish continuation pattern, it is more ideal that it forms after a preceding trend - the longer the better.  
5. Ideally, there should be increasing volume as price breaks through the handle and resistance line. 
6. The pattern's duration can develop over several weeks or even over many months and years.  

As the pattern depicts a type of psychology unfolding in the market - in theory - it can be used on multiple timeframes. However, the lower timeframes may result in more cup and handle failures as price volatility is much higher than on the higher timeframes.  

Whichever timeframe the pattern is traded on, it is not guaranteed price will break out and continue a trend. There are no certainties in the financial markets. However, traders may opt to include other types of analysis to build more probability of one event happening over another. This could include using fundamental analysis such as identifying stocks in strong-performing stock sectors, or other technical analysis indicators such as a momentum oscillator. 

Identifying the Cup and Handle on Stock Charts 

The cup and handle pattern can be utilised on different asset classes but is more commonly used on the stock market. Here are a few visual examples and case studies. 

Netflix (NFLX) 

From September 2018 to February 2020, the price action of US streaming giant Netflix's share price exhibited a rounding, bottoming formation. This cup formation also marked a resistance line at the top. When the price rallied back to this it consolidated for less than two months creating the handle pattern. The bullish trend continuation breakout took place in April 2020.  

The cup and handle pattern on Netflix's weekly share price preceded a long-term trend from 2016 to 2018. Interestingly, it was the handle that lasted the shortest period of time. Most technical analysts state that if the handle lasts for a short period of time, then the breakout can represent a bigger move afterwards. However, this is never guaranteed. The trend also coincided with a demand for online streaming services during the COVID-19 pandemic.  

Associated British Foods (ABF) 

From July to December 2022, the price action of Associated British Foods - a diversified international food and retail group based in the UK - exhibited a rounding, bottoming formation. Some analysts may view the cup as a V-shape rather than a U-shape. This is where discretion comes in as every stock trader and analyst will see different things. The key is to identify the essence of the market psychology the pattern is depicting.  

The cup did form a resistance level at the top and the price rallied back to this point, highlighting a capitulation from sellers and bullish strength. The share price consolidated for several weeks at the resistance point, creating a handle. When the price broke out of the handle, it also cleared the resistance line with a breakaway gap.  

A breakaway gap is a technical term when price gaps through a resistance level and typically occurs early in a trend and is known to be a bullish chart pattern. This is where other types of technical analysis tools can be useful in building a confluence of factors on why the market could move in a particular direction.  

Notably, this example did not have a preceding uptrend beforehand. In fact, during that time the cup and handle pattern developed at the end of a bear market trend in the stock and highlighted a bullish trend reversal. 

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Common Mistakes to Avoid 

While every technical analysis chart pattern depicts a certain type of market psychology unfolding, they vary in size, length and shape. Therefore, it is a form of discretionary analysis in which many traders will agree and disagree using the same analysis on the same stock.  

Therefore, the biggest mistake that should not be avoided is to exercise proper risk management. A breakout of a cup and handle pattern may not materialise, or it could be a false breakout causing the stock price to fall.  

Trading the financial markets involves winning and losing trades and you can lose more than you invest. It is important to keep your risk low and only trade with capital you can afford to lose. A demo trading account can be useful to start as you can practice your skills in a virtual trading environment until you are ready to go live.  

Trading the Cup and Handle Pattern in the UK Stock Market 

The UK stock market has many different stocks that exhibit different technical analysis chart patterns at different times. Here are a few key points to take into consideration.  

1. Choose stocks that have strong liquidity and are well-known. In this instance, sticking to the stocks in the FTSE 100 index or FTSE 350 may be more ideal to identify clearer patterns. These are the 100 and 350 largest stocks listed on the London Stock Exchange by market cap, respectively.  
2. Stick to the higher timeframes such as the monthly, weekly and daily charts to begin with. On lower timeframes, there can sometimes be too many price swings and too much volatility to clearly identify patterns which can also be affected by more false breakout patterns.  
3. Check for other fundamental analysis clues that can act as additional momentum for a breakout. For example, there are many stocks in the oil, gas and commodity sectors listed in the UK stock market. If there is a rally in global oil prices, then profits for companies such as BP and Shell may increase which could lead to a higher share price. 

Entry and Exit Points 

Deciding when to enter and exit a trade is by far the most challenging aspect of trading the market. While patterns can be readily identified, the outcome of those patterns is less clear which is why the timing of entering and exiting is difficult. The most important note to consider here is that no one in the world can enter and exit at the right time all the time as no one can predict the future.  

However, there are certain clues the market may present us that can help to decide possible entry and exit criteria. Let's take an example using the cup and handle pattern that setup on BP's weekly share price during 2020 and 2021.

In the example above, the cup formed between February 2020 and October 2021. The handle lasted a few months before the price broke through resistance in January 2022. Since the price broke through, the share price rallied strongly over the long term.  

However, the volatility was very high with several retests of the resistance level before eventually moving higher. Even then, there were some very big up-and-down swings on the way up and it was not smooth sailing for traders. With this in mind, there are a few different entry techniques to consider.  

The Breakout Entry 

Wait for a candle to close above the resistance line as a confirmation. Buy on the close of the candle with the stop loss at the low of the candle. This is a very aggressive entry and assumes the market will rally higher without looking back which is a rare instance. In the example above, it would have stopped out for a losing trade. Traders could have placed a wider stop loss at a previous swing low in the market but the entry price to stop loss would be very large and would take a very long time to achieve a 1:1 reward-to-risk ratio. 

The Break and Retest Entry 

Wait for the market to cycle away and then back towards the resistance line (1 and 2 on the chart below). This is known as a break and retest setup. After the short-term traders drive the market higher from the break of resistance, their profit-taking causes the price to fall back to the resistance line where longer-term traders may consider entering.  

If waiting for a bullish candle, also known as a buyer candle (a green candle on the chart) as an additional confirmation, two break and retest cycles occurred on 23 January and 13 March 2022. Let's assume a trader entered a buy, or long trade, on the high of these candles, with a stop loss at the low.  

• The first setup went above the high of the candle for several weeks before coming back down and hitting the stop loss which would have resulted in a losing trade. 
• The second setup went above the high of the candle and has since not come back down to the stop-loss level. The profitability of this trade depends on where the trader exited. 

Deciding when to exit a trade is another very challenging decision. Everything is easier in hindsight but in real time no one knows what will happen in the future. When a trader is in profit, then it is even more challenging as now the trader has the emotional burden of winning and losing money which usually causes irrational thinking.  

From a technical analysis perspective, there are multiple exit techniques, such as: 

1. Targeting previous all-time highs, support and resistance levels.
2. Using technical indicators like the MACD to identify when momentum is coming to an end.
3. Trailing stop loss. This involves moving or trailing your stop loss as the market moves in your direction.

A common approach is to trail a stop loss as this can help to lock in gains and protect the trade if the market moves aggressively the other way. However, it can also stop you out early in the move and you may miss out on a large portion of the trend. There is no right or wrong way as no one can predict what happens in the future.  

But if trailing a stop loss, a common question is when to move it? There are multiple options. Some traders may trail it on every bar, when price has reached a new cycle high or at a new swing higher low. Some may add on technical indicators like moving averages and trail the stop loss against it.  

In the chart example below, the 20-exponential moving average (EMA) has been plotted using the blue line. When BP's share price broke and retested from the cup and handle pattern it continued an uptrend which stayed above the 20 EMA until a candle finally closed below it in June 2023.   

Technical Indicators for Entry and Exit Confirmation 

There are a variety of other technical analysis indicators to help identify potential entry and exit points. Here are a few worth mentioning: 

• Moving Averages. As shown in the examples above moving averages can be used as a signal to close a trade when it closes below it. The challenge is that there are many different types of moving averages and periods to use. Therefore, back testing is important but also the understanding that nothing works all the time. 
• MACD. The Moving Average Convergence Divergence indicator measures the momentum of the market. When the MACD histogram starts to fall it is seen as a sign the momentum of the trend is weakening. Traders can use this to be on alert to either move stop losses or scale out of a position.  
• Accumulation/Distribution. The A/D indicator measures volume and price action to determine whether a stock is being accumulated or distributed. Traders may want to see accumulation as price breaks the cup and handle resistance. Alternatively, when the stock starts to show signs of distribution it may put traders on alert to think about exiting a position.  

Stop Loss and Risk Management Importance 

All types of technical analysis chart patterns and indicators only analyse what has happened in the past and cannot predict the future. Therefore, risk management is very important to handle the losing trades where the market does not continue a trend and goes the other way.  

Stop losses can be a very useful tool to help with this. By attaching a stop loss order to open a trade, if the market turns against you, the trade will be automatically closed. This can help to know ahead of time how much you will lose on a trade.  

As the stock market is not open 24 hours a day, there is a risk that the market may gap through your stop loss, and you will lose more than you initially thought. This is why keeping the risk low in the overall portfolio is important. 

Trading Strategies and Tips 

Here are four things to take into consideration when using the cup and handle pattern.  

1. Exercise proper risk management with low risk and the use of a stop loss.  
2. Consider using a demo account to practice your charting and trading skills.  
3. Do not rely on one technique but rather analyse multiple tools and patterns.  
4. Consider trading the technical analysis picture in line with a fundamental narrative. 

Using the Cup and Handle in Bull Markets 

As the cup and handle pattern is a bullish continuation pattern, it may be more suited to a bull market. In a bull market, most investors are bullish about the economy and corporate growth which can exhibit a sustained uptrend in the stock market. This fundamental narrative can act as an additional driving force on top of bullish technical analysis chart patterns.  

Applying the Pattern in a Bear Market 

While the cup and handle pattern is traditionally used as a bullish continuation pattern, there are some instances where it may work in a bear market. Some of the examples highlighted earlier show this possibility. 

As the cup part of the pattern shows a big move lower followed by a significant pullback to where it started, it effectively shows a reversal sign. If this is at the end of the bear market, then the pattern shows the beginning of a bull market.  

However, future price movements in the stock market are highly unpredictable. Therefore, if trying to trade the end of a bear market it is important to keep the risk low and exercise strong portfolio risk management. 

Tools and Resources for Analysing the Cup and Handle Pattern 

One of the most important tools to help analyse the cup and handle pattern is your charting platform. Your platform should be user-friendly to navigate, offer a good range of technical indicators and charting tools and provide real-time data.  

With Admiral Markets, traders can access the MetaTrader suite of platforms including MetaTrader 4, MetaTrader 5 and MetaTrader Web Trader. The MetaTrader 5 platform is particularly suited to stock traders as it designed to be a multi-asset class trading platform and includes the following features: 

• Access real-time data on over 8,000 markets including stocks from some of the largest exchanges in the UK, Europe and US.  
• Utilise 38 built-in technical indicators including moving averages, MACD, average true range, Bollinger bands and more.  
• Analyse price charts with over 14 primary drawing tools including trendlines, horizontal lines, trend channels and Fibonacci levels.  
• Upgrade the standard MetaTrader 5 platform with the Admiral Markets MetaTrader Supreme Edition which offers more trading tools and indicators.

Premium Analytics Screener 

Admiral Markets also offers a technical analysis chart screener for global stocks including UK stocks. The premium analytics screener enables you to search stocks according to region and industry while offering screening parameters such as market capitlisation, technical events, candlestick patterns and more.  

The feature allows you to screen for 28 technical analysis chart patterns helping you to find chart patterns quickly, as shown below: 

Conclusion 

The cup and handle pattern is just one technical analysis pattern of many that is used to help identify bullish continuation moves in the stock market. It represents a market psychology that shows a bottoming formation known in price known as the cup followed by a period of consolidation, known as the handle. As the price breaks through the handle and the subsequent resistance forms at the top of the cup, the theory suggests bullish momentum may continue.  

While no pattern can predict the future, it can be useful when analysing other market information and exercising proper risk management. This could be additional technical indicators to help identify rising and falling momentum, as well as fundamental analysis such as company earnings and financials.   

One challenge is having the ability to analyse thousands of stocks manually. This is where the Admiral Markets Premium Analytics Screener can be a helpful addition. The screener scans for stocks exhibiting classic candlestick and chart patterns, saving you many hours of analysis.

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