The Cup with Handle formation, like most bullish patterns, is always formed during a period of consolidation after a stock has been in an Uptrend for a period of time. Stocks will take a breather during a prolonged trend whether Up or Down. This is the time when stocks form technical patterns such as Flags, Pennants, Channels, Double Bottoms, Head and Shoulders, and yes Cup with Handles. Flags, Pennants, and Channels tend to be much shorter in duration and during strong Bullish Runs these may only be a few days long. Longer Channels, Inverted Double Tops and Inverted Head and Shoulder patterns, many times will also form Cup with Handle patterns within their main pattern. If the reader is unfamiliar with the formation of these patterns and how to use them there are a number of sources available to obtain information of their use. In this article I will be concentrating on the Cup with Handle. In following articles I will explain in detail the Inverted Cup with Handle pattern and the other strategies associated with these two.
To be successful in trading any of these patterns the trader must take the Darvas criteria, discussed in Article One of this series, into consideration prior to entering any trade. First and most important the overall stock market must be in a strong bullish uptrend. All bullish setups will have a high rate of failure in anything other than a strong bull market. The stock must be a leader in its Industry Group and the Industry Group must be one of the top Groups. The company must have a record of producing strong earnings over a period of several quarters. In order to do this they must be producing a product or service that the public has a desire to own or use.
The Cup with Handle acts very similar to the "BOX" method perfected by Darvas. With the aid of computers and software, programs have been created that scan the markets and quickly identify those stocks that meet established criteria. All screen shots used in this series of articles were taken in the TradeStation Platform. All indicators depicted on the charts were developed by DEL Associates LLC using TradeStation’s Easy Language. The following chart is an excellent example of a Cup with Handle pattern.
The LeftSide of the Cup is formed when the stock begins to sell off after a strong uptrend. The base is formed initially as traders begin to take profits driving the price down. The selloff in price is followed with a rounding off as selling slows down and buying begins equaling the selling pressure. The stock eventually becomes oversold and buyers start coming back in. During the development of the base institutional traders are picking up cheap shares. Their desire to buy more shares drives the stock price higher. A few days before the RightSide is formed the prices rises rapidly leading those traders that bought when the price was high,(near the LeftSide) to start selling in order to get most of their money back. This forms the RightSide of the Cup. The Close on the bar that made up the RightSide becomes the Pivot Point Price or Buy Price. The Handle is formed as the selloff begins from the RightSide. At first it will be quite rapid on strong volume but the volume begins to dry up as the weak investors become depleted. Once all the weak investors are out of the stock it has only one way to go, UP. Again the Institutional Traders come storming back in. When the Price crosses above the Pivot Point Trendline on strong volume we have a confirmed “Breakout”. We need to let the price trade 8 to 10 cents above the Pivot Point price before we enter our trade.
(Mouse over Chart for Larger View)
Digital Lightwave (DIGL) formed a classical Cup with Handle pattern in late 1999. This chart shows the price broke out on tremendous volume in mid October 1999 (mouse over chart for larger view). From its breakout price of $8.19 it rose to $75 before forming a second Cup with Handle pattern. After breaking out of the second Cup with Handle the price rapidly reached $150 before succumbing to the dot.com bubble in March 2000. As stated earlier for a company to grow its share price it needed to have a niche in the stock market, offering a product or service the public wanted. Digital Lightwave had developed and patented an essential part used by those manufacturing ATM machines. We do not fall in love with a stock. We only use them while they are making money and then discard them. DIGL quit trading in January 2010 after the price had fallen to five cents a share.
You must become well acquainted with the anatomy of the Cup with Handle Pattern as outlined above before you can comprehend what I will be discussing in future articles. Read the material as many times as it takes. If you have questions please contact the author at firstname.lastname@example.org.
In the next article (Article Three) I will be discussing the Inverted Cup with Handle Pattern. Once you have a good understanding of how it works you will be well equipped to comprehend the relationship between the Cup with Handle and the Inverted Cup with Handle and the Eight Strategies associated with them.