Trading 101 - How To Accurately Identify and Trade the Cup and Handle Crypto Chart Pattern?

2021/08/03 10:40:27

One of the most interesting chart formations of technical analysis is the Cup and Handle chart pattern. Although the pattern is extremely rare, it is worth identifying and knowing how to trade with it accurately. It is one of the most reliable bullish continuation patterns.

By bullish continuation, it means that this pattern only forms when the market is in a bullish trend. Its appearance on the chart implies that the price has undergone a momentary period of consolidation and is about to resume the bullish trend. William O‘Neil first described the pattern in his standard work "How to make money in stocks" (1988).

What is the Cup and Handle Pattern?

The name Cup and Handle is almost self-explanatory. The pattern looks like a coffee cup. However, the bottom mustn't be too deep and not V-shaped – it should be a shallow U-shape. Always ignore chart patterns that look like the Cup and Handle pattern but have a V-shape instead.

Rather a long expansive U-shape characterizes this pattern. The pattern is only completed when the handle has also been formed. This occurs after the prices have risen again for a short time. A breakout from this brief correction creates the buy signal.

Typically, the Cup and Handle pattern precedes the next major upward movement. So, it's worth the wait! This chart formation is basically a rounding bottom followed by a pullback. Therefore, this formation marks a period of consolidation in which the bulls gradually replace the bears.

Identifying the Cup and Handle Pattern

The reason why cryptos form this specific pattern is not known. Ever since O'Neil discussed this pattern in his book, it has always been increasingly easy to spot it on price charts. One might even say it's because of a self-fulfilling prophecy.

As we've noted, this chart formation looks like a coffee cup. However, there are other criteria that traders and investors should pay attention to. Note that some criteria may not be met. For example, the corrections might be stronger than they would be in consolidations in a bull market. Here are some of the features that you should pay close attention to:

  • An initial bullish trend is mandatory. However, the trend is not yet fully formed. That means an upward trend before the start of Cup and Handle consolidation.
  • The cup must have a U-shape. Traders often ignore V-shape formations
  • The "depth" of the cup is preferably a retracement of about 1/3 of the previous bullish price action. In most cases, a 12% to 33% correction from high to low
  • The handle represents the pullback after the new high. It is a final trend reversal, which is generally one-third of the height of the cup. The smaller the retracement, the stronger bullish the breakout is.
  • Trade volume decreases at the bottom of the U-shape and higher volume during the breakout.
  • In a long-term trend, the duration of the 'cup' can be between 1 and 6 months, while the handle usually lasts 1-4 weeks.
  • Obviously, the 'cup' appears on all time frames, i.e., both on daily and weekly charts and in shorter time frames (typically minutes), which are popular with day traders. However, experience shows that it is most reliable on the higher units of time.
  • The profit target (if you want to set it) is equal to the distance between the right high and the bottom of the cup. In most cases, however, the price development shoots far beyond this goal. 

How to Trade The Crypto Market Using the Cup and Handle Chart Pattern?

Remember that the Cup and Handle chart pattern is a bullish continuation chart pattern. This means that the ideal entry price level is when the price action is breaking above the high of the cup (i.e., the brim of the cup). At this point, the bullish trend is trending beyond the previous high before the cup was formed. Always remember to wait until the handle has been fully formed. This is often the conservative entry point. An aggressive entry is appropriate as soon as the pullback from the handle fails.

We can see the formation of the Cup and Handle pattern in the Bitcoin price chart below. All the rules we have discussed above have been respected in this pattern, and the breakout to the north after this pattern formation implies its validity. As discussed, based on your risk appetite, you can either enter the market after the breakout or as soon as you assess the ending of a pullback (ending of the handle).

Formation of the Cup and Handle Pattern on the Bitcoin Price Chart | Source: BTC/USDT

Note that you can also short the market when an inverted Cup and Handle pattern appears. The inverted Cup and Handle crypto chart pattern is the exact opposite of the one we've discussed throughout this article. With the chart pattern Inverted Cup and Handle, you can sell as soon as there is a breakout below the low of the cup or when the pullback of the handle breaks off.

In the below Ethereum price chart, we can observe an overall downtrend. Then the appearance of the inverse Cup and Handle chart pattern indicates that the bearish momentum is about to continue in the crypto asset class after a small pause. Here, we can see the market consolidating after the pattern formation. We must patiently observe the market during times like this before making any quick decisions. After a prolonged fight between the buyers and sellers, the latter party took over, validating the inverse Cup and Handle pattern formation.

Formation of inverse Cup and Handle pattern on the ETH Price Chart | Source: ETH/USDT

Conclusion

As mentioned, remember the Cup and Handle chart formation as a rounding bottom followed by a pullback. Therefore, this formation marks a period of consolidation in which the bulls gradually replace the bears. The last retracement (handle) is the last bearish activity.

As soon as it fails, we expect the prices to rise. It is exactly the opposite when the inverse Cup and Handle pattern is formed in a bear market. But since you can't go short in the crypto spot market, you can always use this pattern while trading crypto futures or any other asset classes where you are allowed to go short. Keep following the KuCoin Blog for more interesting and amazing educational content. All the best!

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