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Technical Analysis of Stock Trends
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Friday September 03, 2010 |
Cup
with Handle
Technically speaking, a cup with handle
is a rally to a new high, a decline of 20 -50 percent over 8 -12
weeks, a rally falling just short of the new high level, a second
decline of 8 - 20 percent over 1 - 4 weeks followed by a breakout to
fresh new highs on strong volume.
Why Does It Happen?
Like most technical patterns, the
cup with handle pattern is really little more than a variation of
another technical pattern. In this case that pattern is the
double top. The pattern begins after a well-liked stock
rallies to a new high following a positive fundamental
development. As the stock surges investors feel increasingly
comfortable paying higher prices but there comes a point when the
"story" of the stock fails to convert new
believers. Slowly, the stock begins to drift lower as those
seeking to lock-in profits outnumber those intrigued by the
story. Although most of the fundamental news is still
positive, many investors begin to question if the stock really is
worth the prevailing market price and over time a substantial
decline begins. This process creates an important technical
peak (top#1). As the stock nears a twenty percent
decline from the recent highs (this decline could reach fifty
percent in bear markets) buyers begin to reassert themselves and
the stock stabilizes and a reaction low occurs. From
this point forward, the bias begins to tilt gradually
higher. During this phase the stock may be the subject of
positive Wall Street analyst comments, a new product announcement
or legal victory. As the rally gains steam sentiment
improves dramatically and new buyers begin to talk about certain
new highs but those that purchased the stock at or near top#1 get
ready to sell. These investors may have been waiting as long
at 12 weeks for an opportunity to sell their positions without
incurring a loss and they are not dissuaded by all of the new
found bullish talk. Just short of the old highs at top#1
aggressive selling begins on no specific news but in reality some
investors that bought near top#1 have already begun to sell.
The stock begins to work significantly lower on increased volume
creating a second, well defined top (top#2). This large
U-shaped pattern may look like a typical double top but for the
purposes of this pattern, it is called the cup.
Noting key resistance at top#1 and top#2, speculators begin to
initiate short positions. From a technical
perspective, this is a very important part of the pattern.
If the stock gains downside momentum and volume continues to
increase, this could very easily become a double top but as the
price works lower, volume slows, sellers seem to be losing the
upper hand. At this point more positive fundamental news is
released and the stock price rallies. With selling pressures
satiated and the flow of fundamental news decidedly bullish volume
increases dramatically and the stock works toward a fresh new
high. This very small U-shaped pullback is called the handle.
Speculators become frantic, they must cover short positions to cut
losses but the supply of stock for sale has been significantly
curtailed because investors that bought at top#1 have liquidated
positions. The next session Wall Street analysts make
positive comments and the stock surges to a new high on
dramatically increased volume. Weeks later the stock trades
at substantial new highs.
How Are Technical targets
Derived?
The technical target for a cup with
handle pattern is derived by adding the height of the
"cup" portion of the pattern to the eventual breakout
from the "handle" portion of the pattern.
Cup and Handle
Pattern for McDonalds Corp.
Vital Signs
-
Cup with handle patterns are
very similar to double top patterns with the exception being
that selling does accelerate after the formation of the second
top, instead the stock consolidates and eventually pushes
beyond overhead resistance on strong volume.
-
Generally, most cup with handle
patterns are completed over the course of 9 -16 weeks and
involve two separate pullbacks of 20 - 50 percent (cup
portion) and 8 -20 percent (handle portion).
-
Upside breakout from the handle
portion of the pattern should occur on strong volume.
This increase in volume verifies that selling pressures have
been satiated.
-
Upside
breakouts often lead to small 2-3% rallies followed by an
immediate test of the breakout level. If the stock
closes below this level (now support) for any reason the
pattern becomes invalid.
Now that we have an understanding
of the cup with handle pattern, let's take a closer look at the
rectangle.
continuation
patterns 
rectangle
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