Free Forex MQL Training

About the Cup and Handle Formation

One of the formations that are worth trading is the cup and handle pattern. It rarely happens in Forex but when it happens the odds that you make huge money with it is very high*. I suggest that you seek this formation on a daily chart rather than other time frames. The cup and handle formation (or rather the cup-with-handle pattern) consists of two significant parts. The first part is a shallow U shape formation that looks like a coffee cup pattern. A consolidation period follows the U shape formation. There are a few characteristics that - if exist - make this pattern more reliable.

• The U shape formation (the cup) is not very deep and it is not like a V shape.
• The cup takes shape in several weeks.
• There is a consolidation period right after the cup which usually lasts for a few days or a couple of weeks at most.

How to Trade Cup and Handle Pattern

If you spot such a formation in a chart you need to wait for the consolidation period then you may enter a trade when the breakout happens. Your stop loss could be the bottom of the cup. If you find this stop very large then initially pick the half way between the top of the cup (U shape formation) and the bottom of the cup. Your profit target could be the height of the cup or if you want to target aggressively double size this height. The following example shows you how to approach this trading opportunity.

The image shows the cup and handle (or cup-with-handle) pattern on the EUR/AUD (Euro versus Australian Dollar) daily chart. The cup part of the pattern has shaped in a period of more than 5 months. You need to wait to see the handle or rather the consolidation part before entering a trade.

Trade Entry: You may enter a trade when you see a breakout from the upper line of the handle. Possible entries could be either point A or point B as shown in the image. The problem with Point A is that you could encounter drawdown for a few days. On the other hand suppose that when the breakout had happened at point A the market had not retraced to create a second breakout at point B. Therefore, entering at point A could guarantee capturing the move. This is not the case in this example but in real trading environment you need to consider every possibility. One safer approach could be entering with half of the expected position at point A and see if another breakout happens and then enter the trade again at that point. This could hlep reduce your risk and also lower your entry level which results in more profit.

Stop Level (Stop Loss): If you can tolerate significant drawdown then use the bottom of the cup or rather point C2 as your initial stop level (1.6046 in the chart). If you cannot tolerate that much of drawdown which exceeds more than 1300 pips then consider C1 as your initial stop level. This means that the worst case scenario is to lose about 700 pips in this trade.

Profit Target (Take Profit): You may consider the height of the cup or rather Point D (1.8808 in the chart) as your profit target. If the price reaches this profit target - which has happened in this example - you would exit the trade with about 1300 pips in profit.

You may alternatively consider double sizing the cup height as your profit target (i.e. Point E or rather 2.0189). If you do so I suggest closing half of your position at Point D and at the same time lock your Stop Loss at breakeven for the rest of the position. This ensures you are secured against adverse movements of the market.

This pattern takes shape over a long period of time. Similarly, when you enter the trade you may stay in it for a few days or even a few weeks. Do not expect a sudden movement in your favour and be prepared for large drawdown extending over a few days. Consider all aspects of trading and money management. Do not jump into the trade without consideration of Risk Reward ratio and the psychological effect of this trade. If you consider yourself a scalper or a day trader then ignore such patterns. It is very likely that you would close such trades early and lose money or miss a great opportunity.

Note: Cup and handle is a bullish pattern. A bearish signal - which I have never seen -could be called an inverted cup and handle pattern in which everything is mirrored with respect to the horizontal axis.

Discuss this article!

*Risk Warning

Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you if you have any doubts. Investatech Inc., its employees or the authors of this website cannot be held responsible for any losses occurred to you due to trading forex or taking advice from this website. Trade at your own discretion.

Top