First, let's start with an illustration of a cup and handle pattern; this will make it considerably easier to define:
Illustration © Investopedia
The beginning, or onset, of a cup and handle pattern generally occurs at the end of an upward trend in a commodity's value; this is indicated by the upward-tilting line at the far left-hand side of the illustration above. At the peak of this upward trend line, some investors will start selling shares; at this point, the left edge of the bowl of the cup is defined in a smooth downward slope. This isn't considered so much panic selling as it is a test of the market. Proof of this comes when the bottom of the cup is formed, and an equally-smooth upward line develops, thus defining the right side of the cup's bowl. Generally speaking, the upper left and upper right edges of the cup are close to the same value, though this may vary slightly.
So there you have the “cup” section of the cup and handle pattern. The “handle”—a slight downward trend in price—is formed when the market is briefly tested again. Once the handle is fully formed, an increase in price appears; in the illustration above, that's the upward-sloping diagonal line on the far right-hand side of the image. In a true cup and handle pattern, the handle should not dip any lower than half the depth of the cup; otherwise, it would simply be considered a full-fledged downward trend.
What does this all mean? Overall, a cup and handle pattern is good news, and reflects an upward-trending, or “bullish,” market. The cup and handle formation represents a testing of the market by investors; if the pattern forms completely, the market has performed to their satisfaction, and the value of the stock or commodity will continue to rise. Generally speaking, the cup and handle pattern forms over the period of a few months or so; the cup taking one to six months to form, and the handle less than a month beyond that. However, industry insiders have observed cup and handle patterns that have taken well over a year to form. As with many chart trend patterns, the cup and handle isn't officially named as such until the upward trend after the handle is formed—but savvy investors can often detect the pattern in the making.
A cup and handle pattern should directly follow an increase trend in value; as we touched on before, the pattern represents just how valid that upward trend really is. Once the cup and handle is formed—and the upward trend continues—it shows investors have tested, and are confident in, the upward trend. Overall, the cup and handle is a positive sign, but its shape and depth could indicate trouble.
One thing to watch closely for in a cup and handle pattern is the cup should be just that—a smoothly-sloping U shape, just like that of the bowl of a teacup. If the cup that forms is a sharp and deeply-declining V shape, this can be a warning sign; it may indicate more intense volatility in the market, and lower investor confidence. Industry experts claim the rise in value after a U-shaped cup is likely to be more solid than one following a V-shaped one. As a matter of fact, the upward trend after a V-shaped cup could be a “false positive,” and the price might start to drop shortly thereafter. Additionally, the depth of the cup should not be any more than 50% of the price increase immediately preceding the cup; a dip any deeper than that could also indicate a higher degree of volatility.
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