How to trade the cup and handle pattern in crypto markets
In one of our recent blog posts, we looked at the best ways to apply pivot points. They are mainly used to determine the overall trend of the market over different time frames. The pivot point is a relatively simple indicator which can be calculated and used on a daily basis for crypto trading.
On the other hand, the cup and handle formation belongs to a different family of patterns. This formation is considered to be a bullish continuation pattern, hence it provides buying opportunities to crypto traders who identify them on charts. They are relatively hard to recognise, but once found, they provide great crypto trading opportunities.
As the name itself says, this formation resembles a cup and handle. The cup is formatted in a “U” shape while the downward drift resembles a handle, which can also sometimes take the form of a triangle.
Structure of the cup and handle
Introduced by chartist William J. O'Neil in the ‘80s, the cup and handle formation is quite straightforward in its design as it consists of two main elements: a cup and a handle. However, this pattern doesn’t occur that often, thus it offers rare trading opportunities. Still, make sure you follow up with a trade once you identify a cup and handle pattern, as it has proved to be a very effective formation.
Let’s analyse the price chart below more closely to see how this works with crypto trading.
The price starts descending, just to create a new low after the previous two swing lows. From that point onwards, it pushes higher in a sustainable fashion, creating high after high. The last high before a pause, or a consolidation phase, is at similar levels to the initial level, from which the price had started descending. As the curved blue line shows, we have a “U” set in place.
Pay attention to the following elements when drawing this pattern: Avoid cup and handles where the cup more resembles a “V” rather than a “U”. The length should be distributed over time as to resemble the “U” shape. In addition, stay away from the overly deep cup shape, where there is quite a long distance between the top and the bottom of the cup shape.
After the price has returned to similar levels around the previous highs, the price action enters into the second phase - consolidation. This mini downtrend occurs briefly, either in the form of a descending channel or a triangle, like in this particular example.
It is important to note that the handle must be smaller than a cup and ideally remain in the upper third part of the cup. In this particular example, the bitcoin price retraced around 25% during the consolidation phase. Avoid trading cup and handle patterns where the handle dips too low or drifts too wide.
Trading cup and handle pattern
The moment the cup and handle formation is activated is the moment the handle, either in the shape of a channel or a triangle, is broken to the upside (see price chart below). It is advised to wait for that particular candle to close before initiating a long trade.
The second step concerns setting a stop-loss order, which is designed to limit our losses if the bitcoin rotates back lower. In a cup and handle pattern, stop-loss should be placed below the lowest point of the handle. As we opened the trade around $1,190 on this particular occasion, the stop-loss is located below the lowest point of the handle - $1,141. Any move or close below this level triggers the stop loss and invalidates the entire pattern.
Finally, we calculate the take profit level by measuring the distance between the bottom of the cup and the pattern’s breakout level, as well as extending that distance upside. Watch for the green diagonal line which connects the low and the breakout and then is copied higher. The profit-taking level in this case is $1,475, which means we risked around 50 pips to make nearly 300. From a risk-management perspective, this is a phenomenal crypto trading opportunity.
The price eventually touched our profit-taking level, around two weeks after the initial breakout took place. It is interesting that the price slightly dipped the moment it got near the profit-taking levels of the cup and handle, which likely means that bigger players played this pattern.
Highly reliable trading pattern, that requires patience
The cup and handle is a bullish continuation pattern that consists of two main elements: cup and a handle. In addition to being rare, cup and handle can take some time before it’s fully formed, indicating one thing - patience is key. However, once identified, according to the aforementioned parameters and conditions, it proves to be highly reliable and efficient.