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How To Trade the Cup With Handle Family of Trades

Article One In This Series

For the past thirty years traders have been trading the Cup with Handle pattern with mixed views on the merits of trading this formation.  Some swear by it, others have met disaster by trying to add it as a tool in their trading arsenal.  After researching and studying this great indicator through many market cycles over the past 15 years I can assure you that very few are knowledgeable of all the tentacles associated with this formation.

Through this forum I am going to use several articles to educate those who are willing to devote the time to understand what the Cup with Handle and those patterns associated with it can really do to increase your bottom line.  Even though there is a lot more to my message than the Cup with Handle pattern discussion, everything is built around the Cup with Handle.  Like any other complex system it is best learned by breaking it down into smaller units.

As we go through this learning process it is extremely important that you fully understand each step before proceeding to the next section to avoid confusion and become discouraged missing out on the opportunity to learn how to effectively trade any market.  First you need a basic understanding of what to look for and why, before any trade is entered.  Many of you will find what I am about to say somewhat familiar, and feel that you already know all about the principles used.  However as we progress you will realize there is much to be learned.

The basis for the method we use was developed by Nicolas Darvas in the mid 1950’s.  Nicolas and his sister were professional dancers that travelled the world performing their dance routine.  During a gig in Canada, he accepted some stock as partial payment for their performance.  Later he sold the stock for a gain and like many of us, became hooked on the game of trading.  I won’t go into detail on everything that led to his success but it is necessary for you to understand what he learned over a five year period as he developed his trading method.  In an eighteen month period in 1958-1959 while traveling through the Middle East he used his method to accumulate over two million dollars.  In his book, published in 1960 entitled “How I Made $2,000,000 in the Stock Market” he goes through each trade that he made listing his entry and exit points.  Today we would look at the title of his book and think it was some (Get Rich Quick Scheme).  His book sold 450,000 copies the first two years.  Most successful traders today use many of the same techniques he discovered and developed over fifty years ago.  Below are some of the most important criteria he used:

  • He looked for young companies that had a niche in the stock market.  They offered a product or service that people wanted.  Notice I said wanted not needed.  People will buy what they want before they buy something they need, i.e. IPhone or IPad.
  • He looked for only those companies that had proven they could make a profit year after year.
  • He only traded those companies that were trading at the highest price they ever traded.  He bought high and sold higher.
  • He used what he called his “Box Method” by drawing a horizontal line connecting the high range and a horizontal line representing the low range thus forming a box.  When the price traded above the top line on strong volume he would enter a trade.  The “Cup with Handle” uses this same method.
  • Strong Volume was a key factor in providing the stock strength to move higher.  Nicolas recognized that for this kind of volume to occur there had to be some large group that recognized the quality of the stock and drove the price up quickly.  Today we call this institutional trading.  In the late 1950’s there were less than 200 institutions trading stocks.
  • Darvas only traded those stocks trading at a price of $25 or above.  This I believe had a lot to do with the fact that it cost as much as $250  per round (100 shares) in commissions to make a trade.  So it only made sense to trade higher priced stocks to get the necessary dollars into the market.
  • He only traded the best stocks in the leading Industry Groups.
  • He entered trades only when the overall stock market was going in the proper direction.   Thus the market had to be in an Uptrend before he would consider entering a trade.
  • He considers one of his biggest mistakes was getting out of a trade too quick.  Because of this he was the first to use what today we call the Trailing Stop.  This would protect his trade if the price moved against him as it took him out of the trade if the stop was hit.  The American Stock Exchange prohibited its use for a period of time because of the success Darvas had with its use.

Darvas’ book is as appropriate today as it was the day it was written.  Many traders today subscribe to his methods though most have never heard of him.  He was also the first to combine both the fundamental and technical methods of trading.  He called it his techno-fundamentalist theory.

His book was published my Senior Year in College, 1960 and I was among those that purchased a copy shortly after it came out.  It has become an inspiration to my never ending quest to become a successful trader.  The onset of the personal computer has lead to endless technical indicators and strategies to assist in trading the markets.  In the early 1980’s I became interested in computers and computer programs.  I was hooked when Super Charts came on the market.  For the first time it enabled the novice trader to take a shot at developing their own system to trade the markets.  From my trading experiences I found that those stocks forming “Channels” and breaking out above them was a powerful trade.  I was working to develop a trading system that would scan for channels and use them as setups for trades.  While attending a Tradestation Seminar someone told me about the Cup with Handle and suggested I give it a try.  That was in 1998 and from that point to the present I have spent hundreds of hours conducting research and development to learn as much as I could about this fascinating phenomenon.  In his book “Think and Grow Rich”, Napoleon Hill stated that “If you spend one hour a day studying a subject, you will be considered an expert after one year.”  I will let you determine my expertise after you finish studying this series of articles, in which I will be explaining in detail the use of the functions, indicators and strategies I have developed using TradeStation’s Easy Language computer code.  Don’t worry it is not necessary for you to learn how to code in Easy Language.  I will be showing you how to use the programs to fit your style of trading.

All I ask you to do is study each article until you thoroughly understand/know the concepts/criteria presented.  For instance it is critical that you understand the bulleted items listed above as you must consider each of them in every trade you make.  By the time you finish this series you will be quite familiar with all of them.  You will be able to look at a chart and have a good idea of the direction it will be moving.  In the next article I will discuss in detail the Cup with Handle pattern.  No matter how long you have been using it you will be able to learn something new.  A complete understanding of the Cup with Handle will give you the background to proceed with the rest of my writings.